EVALUATING BUSINESS MODELS

 

Like seeing the doctor for an annual exam, regularly assessing a business model is an important management activity that allows an organization to evaluate the health of its market position and adapt accordingly. This checkup may become the basis for incremental business model improvements, or it might trigger a serious intervention in the form of a business model innovation initiative. As the automobile, newspaper, and music industries have shown, failing to conduct regular checkups may prevent early detection of business model problems, and may even lead to a company’s demise.

In the previous chapter on the business models environment (see Business Model Environment: Context, Design Drivers, and Constraints), we evaluated the influence of external forces. In this chapter, we adopt the point of view of an existing business model and analyze external forces from the inside out.

The following pages outline two types of assessment. First, we provide a big picture assessment of Amazon.com’s online retailing model circa 2005 and describe how the company has built strategically on that model since. Second, we provide a set of checklists for assessing your business model’s strengths, weaknesses, opportunities, and threats (SWOT) and to help you evaluate each Building Block. Keep in mind that assessing a business model from a big picture perspective and assessing it from a Building Block perspective are complementary activities. A weakness in one Building Block, for example, may have consequences for one or several other Building Blocks—or for the entire model. Business model assessment, therefore, alternates between individual elements and overall integrity.

BIG PICTURE ASSESSMENT: AMAZON.COM

Amazon.com’s main strengths and weaknesses in 2005:

Amazon.com provides a powerful illustration of implementing business model innovation based on an analysis of strengths and weaknesses. We’ve already described why it made sense for Amazon.com to launch a series of new service offers under the moniker Amazon Web Services (see Developing the Story). Now let’s examine how those new offers launched in 2006 related to Amazon.com’s strengths and weaknesses the previous year.

Assessing the strengths and weaknesses of Amazon.com’s business model circa 2005 reveals an enormous strength and a dangerous weakness. Amazon.com’s strength was its extraordinary customer reach and huge selection of products for sale. The company’s main costs lay in the activities in which it excelled, namely fulfillment ($745 million, or 46.3 percent of operating expenses) and technology and content ($451 million, or 28.1 percent of operating expenses). The key weakness of Amazon.com’s business model was weak margins, the result of selling primarily low-value, low-margin products such as books, music CDs, and DVDs. As an online retailer, Amazon.com recorded sales of $8.5 billion in 2005 with a net margin of only 4.2 percent. At the time, Google enjoyed a net margin of 23.9 percent on sales of $6.1 billion while eBay achieved a net margin of 23.7 percent on sales of $4.6 billion.

Looking to the future, founder Jeff Bezos and his management team took a two-pronged approach to building on Amazon.com’s business model. First, they aimed to grow the online retail business through a continuing focus on customer satisfaction and efficient fulfillment. Second, they began growth initiatives in new areas. Management was clear on the requirements for these new initiatives. They had to (1) target underserved markets, (2) be scalable with potential for significant growth, and (3) leverage existing Amazon.com capabilities to bring strong customer-facing differentiation to that marketplace.

Opportunities Amazon.com explored in 2006:

KA & KR Synergies in the use of activities and resources for new offers

VP & CS Two totally new customer segments which are underserved as to the proposed offer

R$ New revenue streams with higher margins than retail

In 2006 Amazon.com focused on two new initiatives that satisfied the above requirements and which promised to powerfully extend the existing business model. The first was a service called Fulfillment by Amazon, and the second was a series of new Amazon Web Services. Both initiatives built on the company’s core strengths—order fulfillment and Web IT expertise—and both addressed underserved markets. What’s more, both initiatives promised higher margins than the company’s core online retailing business.

Fulfillment by Amazon allows individuals and companies to use Amazon.com’s fulfillment infrastructure for their own businesses in exchange for a fee. Amazon.com stores a seller’s inventory in its warehouses, then picks, packs, and ships on the seller’s behalf when an order is received. Sellers can sell through Amazon.com, their own Channels, or a combination of both.

Amazon Web Services targets software developers and any party requiring high-performance server capability by offering on-demand storage and computing capacity. Amazon Simple Storage Systems (Amazon S3) allows developers to use Amazon.com’s massive data center infrastructure for their own data storage needs. Similarly, Amazon Elastic Compute Cloud (EC2), allows developers to “rent” servers on which to run their own applications. Thanks to its deep expertise and unprecedented experience scaling an online shopping site, the company can offer both at cutthroat prices, yet still earn higher margins compared to its online retail operations.

Investors and investment analysts were initially skeptical about these new long-term growth strategies. Unconvinced that the diversification made sense, they contested Amazon.com’s investments in even more IT infrastructure. Eventually, Amazon.com overcame their skepticism. Nonetheless, the true returns from this long-term strategy may not be known for several more years—and after even more investment in the new business model.

DETAILED SWOT ASSESSMENT OF EACH BUILDING BLOCK

Assessing your business model’s overall integrity is crucial, but looking at its components in detail can also reveal interesting paths to innovation and renewal. An effective way to do this is to combine classic strengths, weaknesses, opportunities, and threats (SWOT) analysis with the Business Model Canvas. SWOT analysis provides four perspectives from which to assess the elements of a business model, while the Business Model Canvas provides the focus necessary for a structured discussion.

SWOT analysis is familiar to many businesspeople. It is used to analyze an organization’s strengths and weaknesses and identify potential opportunities and threats. It is an attractive tool because of its simplicity, yet its use can lead to vague discussions because its very openness offers little direction concerning which aspects of an organization to analyze. A lack of useful outcomes may result, which has lead to a certain SWOT-fatigue among managers. When combined with the Business Model Canvas, though, SWOT enables a focused assessment and evaluation of an organization’s business model and its Building Blocks.

SWOT asks four big, simple questions. The first two—what are your organization’s strength and weaknesses?—assess your organization internally. The second two—what opportunities does your organization have and what potential threats does it face?—assess your organization’s position within its environment. Of these four questions, two look at helpful areas (strengths and opportunities) and two address harmful areas. It is useful to ask these four questions with respect to both the overall business model and each of its nine Building Blocks. This type of SWOT analysis provides a good basis for further discussions, decision-making, and ultimately innovation around business models.

The following pages contain non-exhaustive sets of questions to help you assess the strengths and weaknesses of each of your business model Building Blocks. Each set can help jumpstart your own assessments. Results from this exercise can become the foundation for business model change and innovation in your organization.

What are your business model’s . . .

ASSESSING THREATS

We’ve described how business models are situated within specific environments, and shown how external forces such as competition, the legal environment, or technology innovation can influence or threaten a business model (see Business Model Environment: Context, Design Drivers, and Constraints). In this section we look at threats specific to each business model Building Block, and provide a non-exhaustive set of questions to help you think about ways to address each threat.

ASSESSING OPPORTUNITIES

As with threats, we can assess the opportunities that may lie within each business model Building Block. Here’s a non-exhaustive set of questions to help you think about opportunities that could emerge from each of the Building Blocks in your business model.

USING SWOT ASSESSMENT ANALYSIS RESULTS TO DESIGN NEW BUSINESS MODEL OPTIONS

A structured SWOT assessment of your business model yields two results. It provides a snapshot of where you are now (strengths and weaknesses) and it suggests some future trajectories (opportunities and threats). This is valuable input that can help you design new business model options toward which your enterprise can evolve. SWOT analysis is thus a significant part of the process of designing both business model prototypes (see Prototyping) and, with luck, a new business model that you will eventually implement.