1 The Business Model as the Story of How the Company Works

“Those were the days my friend, we thought they’d never end”, Mary Hopkin sang in 1968. It is easy to imagine that the record industry meets annually and sings this refrain because the music industry has been through many and violent upheavals ever since Hopkin’s song was released (Fig. 5.1).

Fig. 5.1
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Redesign Rather than Standstill

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For a long time, most of us bought music in physical formats. Even before that, people mostly went to concerts in order to experience music. Not too many years ago, the common consumption of music was buying CDs and other formats in physical stores like Virgin Megastore and HMV. Throughout the 2000s, as more and more people gained access to faster computers and broadband Internet connections, music became digitized and an increasing number of people downloaded music illegally through services like Napster and The Pirate Bay. The music industry stuck its head in the sand and argued that customers would not want files with inferior sound quality, but that they would rather prefer having the CDs on their bookshelves, being able to touch the album covers and to display their great music tastes through a well-stocked record collection. They were wrong.

Digitization of music and the development of business models that capitalized on new forms of music consumption showed that customers did not require owning the physical music product. Admittedly, vinyl records have received a sales boost in recent years, but they still have a market share of less than ten percent. More and more people are instead willing to access and play music digitally, without having the ability to hold the physical album cover in their hands. Indeed, the value of the album in its conventional sense has gradually decreased in the digital age. The music industry’s reaction was first an attempt to prevent this development. Through copy protection technology, lawsuits against file-sharers and so on, they tried to stop a development that seemed unstoppable. Many musicians were also skeptical about the development. Of course, illegal file sharing went directly at the expense of record sales, and musicians were forced to think in new ways about where their revenues would come from. The entire industry thus needed to adapt to find new ways to create, deliver and capture value.

In 2001, Apple launched the music service iTunes, through which users could buy digital audio files that could be played on their MP3 players, iPods and computers, and eventually also on iPhones, iPads and other devices. This business model was striking, not at least because it managed to challenge the illegal downloading of music, even if it required payment by customers. Its success was perhaps especially due to iTunes making it easy to buy the products, through a simple user interface on an attractive platform. In addition, Apple’s comprehensive contracts with suppliers made sure they had a very rich catalog of music. It is important to remember, however, that Apple’s business model was still based on the customer owning the product—the music—albeit as a digital file instead of as a physical product (see, e.g., Johnson et al. 2008; Osterwalder and Pigneur 2010).

A strong competitor to the iTunes business model emerged in 2006 when the Swedish company Spotify launched its service. Spotify had a new hypothesis about what the customer wanted and instead offered music through a subscription-based streaming service. Instead of buying individual files or albums, customers were now able to stream all the music in the Spotify catalog whenever they wanted and as much as they wanted. Spotify thus changed the consumption of music from providing customers with ownership of the product to providing them with mere access to the music (see, e.g., Stampfl et al. 2013; Gassmann et al. 2014). The situation today is that the physical format (CDs, vinyl records, etc.), digital audio files for purchase (iTunes, Amazon, etc.) and digital audio files for streaming (Spotify, Tidal, etc.) all coexist, but the digital business models increasingly dominate the landscape.

The golden age of the music industry will perhaps never return, and streaming services like Spotify will likely not be the last revolution in this industry. And to keep track with this development, Spotify has recently started hiring research scientists who can work on leveraging the company’s data to deliver better services in an uncertain competitive future. Over time, the story of how music is distributed and consumed has been retold many times. The entire industry can perhaps best be described as waves of subsequent business model innovations—of business models redesigned repeatedly. This is how innovation happens in many industries, although in some more frequently than in others. A natural consequence of this is that many companies and even entire industries perish, precisely because they have not been able to make necessary changes in time. Rather than innovating, they have become victims of the innovative business models of others. But what exactly is a business model, and how can it help us understand how companies work?

1.1 Companies as Stories

The business model is sometimes referred to as the story that explains how the company works (Magretta 2002). What, then, does characterize companies that work? At least, they create value for both the customer and for themselves by offering a product or service that the customer wants and for which he or she is willing to pay. The business model captures the essence of how companies succeed with this in practice (Osterwalder et al. 2014).

If we want to become better acquainted with companies like Spotify and find out how such a company works, we can ask questions such as:

  • What is Spotify?

  • For whom does Spotify exist?

  • How does Spotify create value for itself and for others?

  • Which markets does Spotify operate in, and how does it differ from its competitors in these markets?

  • How do Spotify’s customers pay?

  • How does Spotify ensure that its revenues are greater than its costs so that it remains profitable?

  • What ambitions for growth and scope does Spotify have over time?

A common denominator of business models is that they reflect how companies create, deliver and capture value from business opportunities (Osterwalder and Pigneur 2010; Teece 2010; Johnson et al. 2008). This is illustrated in Fig. 5.2.

Fig. 5.2
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The business model: creating, delivering and capturing value from business opportunities

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There are several ways to define the business model, and one can think of business models as consisting of a set of interrelated components that can be conceptualized in various ways. However, as pointed out by Foss and Saebi (2017) in their review of business model innovation, most definitions seem to converge around the notion that business models comprise the “design or architecture of the value creation, delivery, and capture mechanisms” of a company (cf. Teece 2010). In this book, we similarly build on a conceptualization of the business model that consists of three parts (Jørgensen and Pedersen 2015):

  1. 1.

    Value creation: How the company helps customers to solve a problem or perform a job-to-be-done at a given price (often referred to as the value proposition).

  2. 2.

    Value delivery: The key resources, activities and partners that are needed for the company to carry out what the value proposition requires.

  3. 3.

    Value capture: How the company makes money by means of a given revenue model and a given cost structure.

All organizations consciously or unconsciously operate based on a business model that reflects these three components. We have placed values from business opportunities in the middle of the model since that is what the company is trying to achieve—it represents the opportunity around which the business model is built. Overall, these components tell the story of how the company works, and all three parts are vital to business success.

1.2 Creating Value Through Successful Value Propositions

The first and most fundamental part of the business model is the value proposition, which reflects how the company creates value. It refers to the company’s offering that helps the customer solve a problem or perform a job-to-be-done at a given price (Osterwalder et al. 2014). The “job” metaphor introduced by Christensen et al. (2007) conceives of transactions as customers “hiring” products to do a “job”. Then, it is crucial to understand what type of job the customers need done. And by extension, what does the company offer, and how does it offer it, so that customers are willing to “hire” them again and again?

You use Spotify to solve the problem of how to listen to music in one way, while a physical CD or vinyl record purchased in a record store solves the problem in a different way. Common to both the value proposition of Spotify and of the record store is that they allow you to listen to the music. However, they clearly do it in different ways. Spotify streams the music online and its service gives you access to an endless supply of artists and songs, while you can buy physical records in stores whether they are big or large and whether they are physical stores or online stores. Or you can even stream the music on YouTube and enjoy the music video at the same time—another feature of music services that do different jobs for its users.

Such basic choices are captured in the company’s value proposition, and they are indicative of different solutions to the same basic problem. Successful value propositions have a coherence between what the company offers and what job the customers would like done, as illustrated in Fig. 5.3.

Fig. 5.3
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The value proposition

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Theodore Levitt once said that managers might think that they are selling a drill to the customer. However, it is not a drill the customers want to buy, argues Levitt: It is the hole in the wall customers want (Levitt 1972). The hole in the wall is an example of a job the customer wants done. This reflects the company’s business opportunity: It is an opportunity to create value for the customer at a given price by offering a solution in the form of a product (such as a drill) or a service (such as carpentry). Different customers have different needs. Therefore, they really have different jobs they want done (Christensen 2012). If they feel that other products or services can do the same job, customers will rather choose those products or services. This is particularly true if the substitutes can do an equally good or better job at the same price or at a lower price than what is already offered (Johnson et al. 2008).

It is important to remember that the costs of the customer are not just a matter of money. It is also about time and effort costs (e.g., Christensen 2012). Therein lies another possibility of a business model innovation: new or existing companies can identify problems that are not at present resolved in a satisfactory manner. For example, mobile phones have largely taken over the job done by digital cameras when it comes to photography in everyday life, and a major reason is that they give the user a simple and accessible solution. Even if your company has a value proposition that solves the customer’s problem, there is still a long way to go before both the customer and the company are happy. The next question is how to deliver that value to the customer reliably and over time, and there can be considerable differences between the ways in which companies do so.

1.3 To Deliver What You Promise

Value delivery refers to the configuration of the most important resources, activities and partners that are needed in order to deliver and be paid for the value proposition (e.g., Morris et al. 2005). Simply put, resources are anything the company has, while activities comprise everything the company does. The company owns some resources itself, while it relies on partners to access other resources. For instance, many companies collaborate with research institutions in order to develop new technologies or other inputs. Likewise, companies perform some activities on their own, while other activities are outsourced or carried out in collaborative projects. For example, most banks purchase the IT services upon which their online solutions are built, and some wholesalers collaborate with other players in the industry on joint logistics. Not all resources, activities and partners are equally important, and when telling the story of how the company delivers value, we should therefore concentrate on the most important ones.

Key resources—whether they are physical, human, financial or intellectual—are the inputs required to deliver on what the value proposition promises the customer. It is, however, not enough to possess such resources—the company must use them to perform activities that enable them to deliver value over time (see, e.g., Barney 2001). The company must therefore organize itself in a manner that ensures that it does not need to reinvent the wheel each time the customer knocks on the door. To function properly, companies need to conduct several recurring activities that include everything from budgeting, customer service, manufacturing, training, market research and so on. Without these activities, which comprise both the production of the goods or services the company offers and the support functions needed to do this effectively, companies will neither succeed in delivering on the value proposition nor monetize it (cf. Johnson et al. 2003).

Value delivery thus reflects the strategic and organizational conditions that must be in place for the company being able to create, deliver and capture value over time (Morris et al. 2005; Teece 2010). However, companies cannot do all this just with their own resources. In order to deliver value, they need suppliers and partners, whether to provide resources the company itself does not possess or to perform activities it cannot carry out on its own (e.g., Dyer and Singh 1998). In this way, partners can unlock new modes of value delivery for the company. In other words, there are costs to delivering value to the customer. Therefore, in order to be profitable, the solution offered to customers must cost less to produce than the customer is willing to pay for it. This necessitates, however, that the company manages to capture value through an effective logic of profitability.

1.4 Getting a Bigger Share of the Pie

We have seen above that the value proposition is the offering that helps the customer to solve a problem at a given price. It does not take much imagination to understand that it is costly for companies to obtain the necessary resources and to use them to perform value-adding activities. The story of how the company works must therefore also include a logic of profitability (Johnson et al. 2008). How does the company generate profitability by means of a given revenue model and a given cost structure? What is the relationship between the price of the offering and the volume sold to customers? The logic of profitability will also include more specific measures, such as how much the company must make on each transaction and how quickly resources and inventory must be turned over to achieve the desired level of profitability.

How companies capture value has become such a central topic that the various payment models have gotten their own names. Spotify’s main payment model is a subscription service, while the model advertising-funded version Spotify uses is often called the “free model” (or just “free”). The media companies have offered online newspapers for a long time, but we now see that several online newspapers are beginning to charge in different ways. These models are given names like “total payment”, in which customers have to pay for everything; the “metered model”, in which customers receive a number of free articles in a given period; and “freemium”, in which customers are offered a combination of free and paid content.

Note that these names reveal only a little about how the company actually creates value and how it is delivered to its users. Two newspapers that use the total payment model can address very different segments with very different content, and they can deliver their value propositions in a variety of ways, based on dissimilar resources and activities. It is therefore important to be aware that value capture is an important part of the story of how the company works, even though it may not always be the most telling part of the business model.

Many companies, such as Würth, Volvo and Rolls Royce, have traditionally generated revenues by producing and selling products. In recent years, however, it has become more common that they also offer services by leasing their products to customers. Consequently, they have developed a business model using the so-called servitization, product service systems or product-as-service, by which companies lease products rather than selling them (see, e.g., Jørgensen and Pedersen 2017; Scholl 2006). This implies that the customer is still paying for the physical product, but as a service (i.e., functionality) rather than as a product of which the customer takes ownership (cf. Bocken et al. 2016). Moreover, the customer therefore also pays in other ways than when purchasing the product in a conventional way, which implies that the profitability logic is changed because of the change in the value proposition.

1.5 The Hypothesis of What the Customer Wants

It is obvious that the arrival of iTunes and Spotify turned the music industry upside-down. Any business model is based on a value proposition, which in turn reflects a hypothesis about what the customer wants. This hypothesis can of course be right or wrong. A successful business model is able to offer what the customer actually wants at a price the customer can accept, and successful business models both create and deliver value in a way that enables the company to capture value for itself and its owners (Kaplan 2012).

The business models of the music industry, which we have used as examples, have reflected three somewhat different hypotheses about what kind of problem customers want to have solved (Table 5.1). In addition, through their intense growth, the new digital music services have made life difficult for the more traditional players in completely different industries since they actually also solve some of the problems of customers who have previously used the products or services of firms in those industries. For instance, when more and more people use Spotify’s services on their office laptops or through their mobile phones connected to the car stereo, it means that they are also making life more difficult for radio stations competing for the same customer attention. Similarly, social media like Facebook and Twitter are trying to outcompete the traditional hypothesis that “the customer wants a newspaper that presents the most important news from the past day”, or for that matter the more recent hypothesis that “the customer wants the website of a newspaper to update with news in real time”.

Table 5.1 The business models of various music services
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From time to time, new business models emerge based on new hypotheses about what the customer really wants (Christensen 2012). In such situations, established players quickly lose their customer base. It is enough to recall what happened to the market for relatively inexpensive digital cameras: after Apple, other producers began to integrate good camera features in the iPhone and other smartphones. Companies like Canon and Kodak became “victims” of such business model innovation. This involves a new hypothesis about what the customer wants, a new way to deliver value or new ways to charge the customer for the value, for instance, via a new payment model. In such a situation, standing still might be a recipe for disaster for many companies. In other words, it might be necessary to redesign the company’s business model in order to meet the competition. Here, the case of Fujifilm—as a contrast to the plight of Canon—can be instructive. When realizing that digitalization would transform the photography (camera and film) industry, Fujifilm redefined its business as being related to imaging more broadly and successfully entered new markets in medical imaging, information technology and so on (see, e.g., Inagaki and Osawa 2012). In this way, the company steered clear of the downfall that some of its competitors faced.

We have not yet heard the swan song of the music industry. However, the many innovations in the industry imply that old giants might be about to fall and that new players will enter the stage and outperform existing solutions with new products and services, new technologies and new payment models. The challenge for companies in the music industry and in many other industries is to reinvent themselves before someone else makes them redundant.

2 Redesigning Business Models

Stanford University is widely known as the hotbed of many of the most successful technology companies in Silicon Valley. But did you know that successful companies have also emerged from the relatively less glamorous study halls of the University of Bergen, Norway?

In 1997, Siri M. Kalvig was already widely known as Norway’s first female weather presenter. As a young meteorology student, however, she went on to establish Storm Weather Center with the equivalent of a few thousand dollars in initial capital. In 2014, the Swedish private equity company EQT bought her weather forecasting company, which by then had been renamed StormGeo, for approximately 200 million USD.

What happened on the way in order to enable this massive growth? A possible answer to the question is the way in which Kalvig and her colleagues reformulated the story of the company when they went from being a company that reported the weather to become a company that also reported the consequences of the weather. StormGeo had long delivered weather services for television, newspapers and digital platforms. However, after the reformulation of what it was supposed to be, and for whom, a door was opened to an ocean of new and exciting business opportunities (Jørgensen and Pedersen 2015).

The ocean was also the arena for which the company specialized: StormGeo has developed a range of services that it sells to companies in the shipping, offshore and oil and gas industries. These companies are highly dependent on the weather and the need for timely and reliable information on how their operations are affected by the weather. StormGeo offers decision support systems to enable the weather-sensitive operations of these companies. An example of this is a service that helps shipping companies choose routes that allow them to use the force of the currents in the ocean, thus reducing both their fuel consumption and their environmental footprint. All of StormGeo’s services originate in the same resource that rendered StormGeo able to deliver its original service of weather reports on television and other platforms. When the managers began to think again about other ways that these resources could be used, it led to a green innovation that proved to be very profitable. This resulted in a comprehensive redesign of the company’s business model.

StormGeo has offices and customers all over the world, and a common characteristic of its customers is that they need knowledge about the consequences of the weather. From being a company associated with regular weather forecasts, StormGeo has retold the story of what it will deliver to whom, how this should be done and how to charge the customer for its services. StormGeo is thus an example of a company that has discovered the possibilities inherent in the sustainability issue and has adapted its business model accordingly. Kalvig has long been a pioneer in the battle against climate change, and she has said that the business model innovation of StormGeo has been motivated in part by a desire to take responsibility for contributing to climate solutions, while at the same time embracing the opportunities inherent in the climate problem.

2.1 Innovation of Business Models

Innovation involves renewal, novelty and change, and we usually think of it as a positive concept. Innovation is not just about new products and services—it also relates to innovation of business models (Chesbrough and Rosenbloom 2002); in other words, changes in the way companies create, deliver and capture value. This means that innovation can occur in connection with all three components of the business model: First, it may be an innovative value proposition offering new types of value. Second, it may be linked to value delivery, for example, with regard to the innovative use of resources or design of value-adding activities alone or in collaboration with others. Third, it can be linked to value capture, for instance, in the form of innovative payment models or novel revenue streams.

As pointed out by Schumpeter (1911), innovations vary in their degree of novelty. Zott and Amit (2007) argue that business model designs differ in the degree to which they are centered on efficiency or novelty. Mirroring this distinction, it is common to distinguish between incremental and radical innovations (Ettlie et al. 1984; Dewar and Dutton 1986). Although the latter type gets most of the attention, research shows that most innovations are in fact incremental. Incremental changes take place gradually, while radical changes entail an abrupt break from existing solutions.

A much-discussed type of radical innovations are the so-called disruptive innovations (Christensen 2012). This refers to new products or services that deviate radically from existing offerings, typically by being simpler and less expensive (Johnson et al. 2008). This implies that they usually make a technology or new solution available to many more people. Such innovations often turn markets upside-down, and a typical example is how mobile cameras disrupted the market for more expensive and more advanced digital cameras. The first mobile cameras had significantly poorer quality, but their quality was sufficient and customers found it easier to use them. Hence, as their quality gradually improved, they completely overtook the mass market for photography.

When talking about business model innovations, one often immediately thinks of such radical changes by which new or established businesses change the rules of the game in an industry by changing the way value is created, delivered and captured. Spotify’s entry into the music industry is a good example of this. Spotify’s hypothesis about what the customer wanted differed significantly from the existing hypothesis. Importantly, the new hypothesis was based on the assumption that ownership was not important. Customers could access the streaming service either by paying a monthly subscription fee or by choosing an advertisement-funded version. Therefore, Spotify also had to show that it could solve a problem for advertisers: after all, ad revenue was supposed to finance part of its operations.

Spotify’s value proposition was a novelty, and it required that the company managed to convince several different stakeholders—customers, record companies and artists—that its solution was attractive and useful. Spotify also needed to acquire completely different types of resources and perform completely different types of value-adding activities compared with what previous distributors of music had done. Not at least, their business model had a new way of capturing value—a payment model that made it likely that customers would use it. Overall, Spotify’s business model innovation resulted in an entirely new way of thinking that challenged the rules of the game in the industry.

2.2 Disrupt or Die?

Companies that do not innovate and change when needed are in danger of becoming “netflixed”, to use Saul Kaplan’s (2012) phrase. Similarly, there is often speak of the “uberification” of various markets. The radical shifts that have characterized, for instance, the entertainment industry and the taxi industry seem to have created a concern across all industries that the next radical innovation is waiting around the next corner.

Netflix, which today is best known for its offering of TV and movie streaming, started in the late 1990s as a company that offered customers DVD rentals online. At the time, it was common to go to the rental kiosk and rent movies, and Netflix was established as a response to one of the founders having to pay a late delivery fee. Later, Netflix also introduced the service we know today, which is based on the streaming of movies and TV shows online.

One consequence of the success of Netflix was that the rental giant Blockbuster went bankrupt. Blockbuster was unable to renew itself, and thus became a victim of Netflix’s innovative services. For companies to survive and grow, they sometimes need to change the story of how they function, and they do this through changes in how they create, deliver and capture value. Blockbuster was not able to adapt—first from a traditional rental store to a provider of online rentals, and thereafter to online streaming. An interesting part of the story is that Blockbuster was invited to buy Netflix for 50 million USD in the early 2000s. At the time, however, it did not realize the potential of Netflix’s new business model and therefore declined the offer. Ten years later, the market value of Netflix was nearly 20 billion dollars.

The innovation researcher Clayton Christensen argues that established companies are best at doing incremental innovations, which often involves making a product as sophisticated and as good as possible (Christensen 2012). The problem is that such products often become so advanced that almost only the most ardent and wealthy clients can afford or need them. That creates an opportunity for newcomers that have the opportunity to enter the market with cheaper and simpler products or services able to reach new customer groups. A classic example is the computer industry, in which clear patterns emerged over time. The big players competed to get better storage, and PCs became bigger, stronger and better. Surprisingly, however, new players emerged in the market with small, laptop computers with less storage capacity. These new products initially addressed very different customer segments, and the established companies had not been able to see these opportunities. Instead, they were very fixated on more incremental innovations through which they were creating improved versions of what already existed.

One of the reasons that incumbents fail to come up with disruptive innovations is perhaps that they are too busy to meet (what they believe) are the needs of existing customers—that is, that they are ridden by “marketing myopia” (Levitt 1960). To innovate successfully, it is necessary to break free from the mindsets that block new ideas and solutions. In other words, successful innovators fail to reinvent when they do not turn their attention from making improved products to try to solve the real job the customer wants done instead. Because what is really the customer’s “hole in the wall”? There is no use in creating an even more powerful and better drill if your competitors are simultaneously launching products or services that help customers solve the problem in a cheaper and easier way.

In the music industry, the long-lasting established truth was that the customer wanted to own the product, whether it was a CD or an MP3 file. Spotify, however, proved that it is sufficient for most customers to access music through streaming services, even if that also requires them to have a physical product in the form of a computer, smartphone or the like. In many ways, streaming music is also an inferior product: The sound quality is allegedly slightly worse, artists reportedly receive less pay and customers who use the free version of the service are somewhat bothered by the advertisements. Nevertheless, customers are increasingly migrating toward these services, and Spotify has even largely managed to oust illegal music file sharing online because they offer a set of services that customers find attractive enough to pay the subscription fee. Importantly, however, the company is still struggling to become profitable and therefore needs to continue fine-tuning its business model (e.g., Hufford 2017).

StormGeo’s redesign of its business model was slightly different. Kalvig and her colleagues simply discovered that their existing resources could be used to solve much bigger problems than what they were initially doing. Thus, the company was able to offer much more profitable services. StormGeo reformulated its value proposition and redesigned its organization in a manner that rendered it able to deliver these services in a way that was attractive to entirely new customer segments.

The concepts innovation and entrepreneurship are closely related, and it is difficult to imagine innovation without entrepreneurs, whether in the form of the so-called intrapreneurship or outside the company. Entrepreneurs are willing to take risks, and they are often rule-breakers in a positive sense—by questioning and experimenting (cf. Christensen 2012). Some entrepreneurs even manage to develop completely new and often disruptive business models. Even in established companies, there are “ intrapreneurs” who find new ways to rearrange the building blocks of which the company consists, in order to rewrite the story of the company.

It is said that organizations are born as movements and die as institutions. Being in motion can therefore be understood as a fundamental prerequisite for companies to survive and grow over time. New ideas and business models challenge the old, in the music industry as in most other industries. Companies that do not want to be “netflixed” should therefore look over their shoulders and ask themselves how they should change in order to prevent others from making them redundant. Standing still is not an option—in the future, companies will have to redesign their business models more and more frequently. In order to be successful, however, such changes will require experimentation, which is the topic of the next chapter.