The Business Model

To extract value from an innovation, a start-up (or any firm for that matter) needs an appropriate business model. Business models convert new technology to economic value.

For some start-ups, familiar business models cannot be applied, so a new model must be devised. Not only is the business model important, in some cases the innovation rests not in the product or service but in the business model itself.

In their paper, The Role of the Business Model in Capturing Value from Innovation, Henry Chesbrough and Richard S. Rosenbloom present a basic framework describing the elements of a business model.

Given the complexities of products, markets, and the environment in which the firm operates, very few individuals, if any, fully understand the organization's tasks in their entirety. The technical experts know their domain and the business experts know theirs. The business model serves to connect these two domains as shown in the following diagram:

Role of the Business Model



Technical
Inputs

Business
Model

Economic
Outputs



A business model draws on a multitude of business subjects, including economics, entrepreneurship, finance, marketing, operations, and strategy. The business model itself is an important determinant of the profits to be made from an innovation. A mediocre innovation with a great business model may be more profitable than a great innovation with a mediocre business model.

In their research, Chesbrough and Rosenbloom searched literature from both the academic and the business press and identified some common themes. They list the following six components of the business model:

1.Value proposition - a description the customer problem, the product that addresses the problem, and the value of the product from the customer's perspective.
2.Market segment - the group of customers to target, recognizing that different market segments have different needs. Sometimes the potential of an innovation is unlocked only when a different market segment is targeted.
3.Value chain structure - the firm's position and activities in the value chain and how the firm will capture part of the value that it creates in the chain.
4.Revenue generation and margins - how revenue is generated (sales, leasing, subscription, support, etc.), the cost structure, and target profit margins.
5.Position in value network - identification of competitors, complementors, and any network effects that can be utilized to deliver more value to the customer.
6.Competitive strategy - how the company will attempt to develop a sustainable competitive advantage, for example, by means of a cost, differentiation, or niche strategy.