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What makes the business models of innovators in the 21st century competitive?

Introduction

Innovative 21st century business models contain many aspects that differentiate them from business models that are more closely associated with the pre-internet era.

Innovative organisations are able to utilise disruptive technologies and approach business strategy from a different perspective to traditional companies and use this to digitise their business and develop a business model that enables them better respond to the increasing pace of change in industries, and so create competitive advantage.

The ability to develop and utilise intangible assets such as knowledge, organisational routines, and intellectual property to achieve competitive advantage separates innovative businesses from physical asset focused organisations but is not without its risk, and so absorbing change and dealing with uncertainty become essential in maintaining competitive advantage.

Organisations with innovative business models are able to leverage the advantages of network externalities to achieve cost efficiency, customer lock-in, complementary value and first-mover advantage to hold a competitive advantage over companies that fail to utilise network effects in their business.

Purpose and societal impact can be sources of competitive advantage for organisations that contribute positively to environmental, societal, or human issues,

All of these elements impact modern business models and contribute to an organisation’s ability to achieve and maintain competitive advantage in the 21st century.

Digitisation, technology and strategy

The 21st century has seen a huge increase in disruptive technologies such as the internet, social media, artificial intelligence, blockchain, robots, and IoT entering almost every market including the music industry, banking and finance, engineering and manufacturing, and recruitment and HR. Organisations that make use of these disruptive technologies can gain a competitive advantage over competitors who are slower to appreciate the benefits and undertake the digitisation of their business. Whilst slower-to-adapt, traditional companies rely on functionality to beat competitors, modern companies beat competitors with speed and customization (Christensen, 2001).

The increasing speed of change in the digitisation (Kurzweil, 2004) of business places pressure on innovative organisations to be continually evolving in order to keep pace with the change and remain competitive. As Porter noted when describing how a competitive advantage is achieved through cost leadership and differentiation, “The ability to be both low cost and differentiated is a function of being the only firm with the new innovation” (Porter, 1980: 3). This suggests that competitive advantage viewed in this way is easily lost to companies that use the next newly available disruptive technology to differentiate themselves. However, those companies that approach innovation as a continual creative destruction (Schumpeter, 1934) of their own practices, products and services, and even business model can successfully utilise digital technologies in strategies that ensure they maintain a competitive advantage.

This pressure to continually reinvent any and all aspect of a business has driven a shift in how organisations approach innovation from closed innovation in which businesses generated their own ideas and develop them internally, to open innovation 1.0 in which companies combine internal and external ideas to accelerate their innovation process (Chesbrough 2003) and onto open innovation 2.0 in which ideas are developed within an ecosystem of industry, universities, government and communities (Curley and Salmelin 2013).

“BMW Group faces many innovation challenges for which it doesn’t always have immediate in-house solutions, so we choose to search globally for the technology that we need, particularly among the innovators who are running startup companies. That is why the BMW Group has, in conjunction with StartupFest Europe 2017, challenged startups from across Europe, working in all fields related to mobility products or services, to submit their pioneering technology, product or service ideas for a competition that offers a chance to become part of a pool that buy billions of dollars’ worth of products and services every year.” (Gimmy, 2017). Companies, such as BMW, adopt an innovation 2.0 approach in order to develop a broader range of ideas more quickly and without the resource constraints of needing to employee experts in all areas of development, and the company that does this better than their competitors can achieve competitive advantage.

Intangible assets and absorbing change

Whilst Porter asserted that competitive advantage comes from providing value to customers at a higher value than it costs to provide, Barney’s view was that competitive advantage is achieved by “implementing a value creating strategy different from the strategies of its competitors.” (Talaja, 2012). This advantage can be achieved when a company possesses and exploits valuable, rare, inimitable, and non-substitutable resources and capabilities (Barney, 1991).

For modern innovative organisations using business models that rely on intangible assets such as software, organisational routines and specialist knowledge, using this resources-based view allows for an understanding that excelling at creating and managing intangible assets is essential for establishing and maintaining competitive advantage. As new models of open innovation emerge that rely on developing eco-systems from partnerships across industry boundaries rather than exclusively within a business (Curley and Salmelin 2013), knowledge becomes more important and the challenge of retaining that knowledge needs to become an essential part of an innovative organisation’s strategy. Nonanka’s Dynamic Theory Of Organisational Knowledge Creation describes how in learning organisations knowledge moves from tacit to explicit in a continual dialogue where new knowledge is developed by individuals and transferred to organizations (Nonaka, 1994). This knowledge transfer is an essential part of companies ensuring they maintain the competitive advantage gained from creating and retaining intellectual property.

Teece and Pisano argue that “the competitive advantage of firms stems from dynamic capabilities rooted in high performance routines operating inside the firm, embedded in the firm’s processes, and conditioned by its history” (Teece & Pisano, 2003). However, there are risks to businesses in relying solely on their organisational routines and unique intellectual property to achieve competitive advantage. Over time, organisational routines can become settled and need to be refreshed in order to ensure they are indeed high performing given the constant change in today’s markets, and specialist knowledge and intellectual property can become locked in the minds of founders and employees which creates a risk to the business if those people leave the company.

More recently, Teece, Peteraf and Heaton have explored ideas around “fostering the organizational agility necessary to address deep uncertainty, such as that generated by innovation”. They point out the differences between managing risk in a traditional way and dealing with the deep uncertainty that is a characteristic of “interdependent economies experiencing rapid technological change and financial disruption” (Teece, Peteraf & Heaton, 2016). In order to maintain its competitive advantage an organisation needs to ensure it’s dynamic capabilities provide it with the means to absorb and respond to change quickly and use its response to change to improve its dynamic capabilities.

Network externalities and cost efficiency

For organisations following Porter’s Cost Leadership strategy (Porter, 1985) and so concerned with reducing transaction costs in order to lead on price within the market, digitisation enables cost savings (Lucking-Reiley & Spulber, 2001). For internet-era ‘digital-first’ organisations with digital-only products and services, transaction costs can be shrunk to near zero. Innovative organisations can utilise network effects to increase their customer base and so achieve scale faster and more cost-effectively than businesses with lesser digital business models.

Network effects can be expressed as the value that a product provides the customer, and so the business, increases as the number of users grows (Katz and Shapiro, 1985). Two examples of utilising network effects are interaction, where a product is only useful if a number of other people are also using the product, and compatibility, where customers purchase and use software that is compatible with other software that they are those they interact with are using (Katz and Shapiro, 1985). A study by NFX of digital companies that went on to become worth more than a $1 billion, estimated that network effects have accounted for approximately 70% of the value creation in tech.

These elements creates a lock-in effect where the cost (financial, but mostly in loss of value from interacting with and being compatible with others) of stopping use of the product is greater than the cost of continuing to use it (Farrell & Klemperer, 2007). Organisations that successfully leverage lock-in and so increase the switching costs for customers have the potential to dominate a market and make it very difficult for new entrants to gain market share, which becomes a key strategic advantage in maintaining competitiveness.

Utilising Internet technologies and network effects allows companies to increase the value offered to their customers by providing bundles of complementary products and services (Amit and Zott, 2001). These complementarities “are present whenever having a bundle of goods together provides more value than the total value of having each of the goods separately”, and those bundles may be made up from products and services owned by the business or by businesses offering services from other organisations that complement their own product (Amit and Zott, 2001). Whereas businesses that don’t leverage network effects may offer bundles in the form of ‘two for one’ or other such offers, companies with innovative business models are able to offer complementariness in a way that becomes a distinct competitive advantage. When customers recognise increased benefits they are likely to get from purchasing from a business that offers products or services with bundled complementariness in contrast to purchasing from business that don’t, the increased adoption can contribute to the innovative business increasing market share and maintaining competitive advantage.

Having already looked at three elements of Amit and Zott’s sources of value creation in e-business, Novelty is the fourth aspect that drives value. The “introduction of new products or services, new methods of production, distribution, or marketing” and ways of doing business enables innovative businesses to gain first-mover advantage (Amit and Zott, 2001). Where newness and first-mover advantage drives value for a business it can be leveraged to be a competitive advantage in conjunction with the other sources of value creation.

Purpose and societal impact

Although the role of business in society changes over time, society is expected to provide an environment that business can operate in whilst businesses provide products and services for the members of society in exchange for economic returns (Cannon, 1994). 21st century innovative businesses can build upon this relationship by providing an environment and work that is purposeful (Sgori, 2014) in order to help creative knowledge workers feel that they are contributing to a positive impact on the world.

Etsy, the ecommerce marketplace company selling handmade and vintage items, is an example of how a business can balance profit and purpose. Etsy holds a B-Corp certification, showing it meets the highest standards of social and environmental performance. It also runs a free entrepreneurship courses to underemployed and unemployed residents in collaboration with the US government (Hakimi, 2015).

Having purpose also has a positive effect on employee morale. A report by the Society for Human Resource Management revealed that companies with strong sustainability programs had 55% better morale, 43% more efficient businesses processes, 43% stronger public image, and 38% better employee loyalty (SHRM, 2018). These reports all contribute to the idea that a business that has a positive societal impact can achieve attract and retain employees that have greater commitment and contribution to the company.

An article on the Moving Worlds blog lists nine innovative companies with a social purpose and includes lessons from them such as “customers seek out brands that align with their morals” from Patagonia, Salesforce’s donating of “1% of revenue, products, and employee time towards charitable work”, and Social Capital’s use of “data techniques to evaluate investments that contribute to social good by covering sectors including education and healthcare” (Barbu, 2018) as purpose-driven business models that demonstrate commercially success. These and a multitude of other examples show how having a purpose is more than just good public relations, it can be a source of differentiated competitive advantage for any kind of business.

Conclusion

Many varied things are involved in making the business models of innovators in the 21st century competitive. There are many theories that contribute a partial understanding to these various aspects of innovation and business but clearly there is no single dominant model or intellectual framework that provides an accurate lens for understanding what it takes to be a successful, innovative businesses in the 21st century. Disruptive technologies and the digitisation of every kind of business and industry have widened the gap between those innovative organisations that are able to respond to the increasing pace of change and those that are being left behind. Organisations that are able to utilise technology also need to be able to successfully manage their capabilities, intellectual property and other intangible assets such as employee knowledge in ways that create advantages over competitors. Having a clear approach to value creation through efficiency, complementarities, lock‐in, and novelty offers companies yet another aspect of successful innovation, and having a positive impact on society, offer yet more things for a business to consider as it invents its innovative business for competitive success in the 21st century.

References

Christensen, C. (2002). The Past and Future of Competitive Advantage. MIT Sloan Management Review.

Kurzweil R. (2004). The Law of Accelerating Returns. In: Teuscher C. (eds) Alan Turing: Life and Legacy of a Great Thinker. Springer, Berlin, Heidelberg.

Porter, Michael E. (1985). Competitive Advantage – Creating and Sustaining Superior Performance. The Free Press, A Division of Macmillan, Inc.

Schumpeter, Joseph. (1934) The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle. Harvard Economic Studies.

Chesbrough, Henry William. (2003). Open Innovation: The New Imperative for Creating and Profiting from Technology. Harvard Business Press.

Curley, Martin & Salmelin, Bror. (2017). Open Innovation 2.0: The New Mode of Digital Innovation for Prosperity and Sustainability. Springer, 5 Oct.

Gimmy, Gregor. (2017) Who will win the BMW Startup Challenge? startupfesteurope.com

Talaja, Anita. (2012). Testing VRIN framework: Resource value and rareness as sources of competitive advantage and above average performance. Management (Croatia). 17. 51-64.

Barney, Jay. (1991). Firm Resources and Sustained Competitive Advantage. Journal of Management. 17: 99.

Nonaka, Ikujiro. (1994). A Dynamic Theory of Organizational Knowledge Creation. Organization Science, Vol5 No1 February.

David Teece. Gary Pisano. The Dynamic Capabilities of Firms. Handbook on Knowledge Management pp 195-213. Springer, Berlin, Heidelberg. 2003.

Teece, David. Peteraf, Margaret A. Heaton, Sohvi. (2016). Dynamic Capabilities and Organizational Agility: Risk, Uncertainty and Entrepreneurial Management in the Innovation Economy. California Management Review.

Lucking-Reiley, David & Spulber, Daniel F. (2001). Business-to-Business Electronic Commerce. Journal of Economic Perspectives—Volume 15, Number 1—Winter 2001—Pages 55–68.

Katz, Michael L and Shapiro, Carl. (1985). Network Externalities, Competition, and Compatibility. The American Economic Review Vol. 75, No. 3 (Jun. 1985), pp. 424-440.

NFX, (2017). 70% of Value in Tech is Driven by Network Effects. Medium.com

Farrell, Joseph & Klemperer, Paul. Coordination and Lock-In: Competition with Switching Costs and Network Effects. Handbook of Industrial Organization. Volume 3, 2007, Pages 1967-2072

Amit, Raphael & Zott, Christoph. (2001). Value creation in e-business. Strategic Management Journal, 22: 493–520 (2001). The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania, U.S.A.

Cannon, Tom. (1994). Corporate Responsibility. A textbook on Business Ethics, Governance, Environment: Roles & Responsibilities. Pitman Publishing.

Sgroi, Anthony Jr. (2014). The Innovative Lean Machine: Synchronizing People, Branding, and Strategy to Win in the Marketplace. CRC Press.

Hakimi, Sherry, (2015). Why Purpose-Driven Companies Are Often More Successful. fastcompany.com

Zukin, Cliff & Szeltner, Mark. (2012). What Workers Want. Net Impact Talent Report. John J. Heldrich Center for Workforce Development Rutgers, The State University of New Jersey.

BSR and Aurosoorya. (2018). Advancing sustainability: HR’s role. A research report by the Society for Human Resource Management.

Barbu, Petra. (2018). Doing Well by Doing Good: What We Can Learn From 2018’s Most Innovative Companies. Movingworlds.org.

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