FormalPara Definition

A firm’s business model refers to the system of interdependent activities that are performed by the firm and by its partners, suppliers and customers to fulfil a customer need.

A firm’s business model is the structural template of the way the firm conducts its business. It describes the system of activities that are performed by the firm and by its partners and the ways that these activities are linked to each other through transactions in factor and product markets. The overall objective of a focal firm’s business model is to exploit its business opportunities by creating value for all the parties involved; that is, to fulfil customers’ needs and create customer surplus while generating a profit for the focal firm and its partners (Amit and Zott 2001). An activity in a focal firm’s business model can be viewed as the engagement of human, physical and/or capital resources of any part to the business model (the focal firm, end customers, vendors etc.) to serve a specific purpose toward the fulfilment of the overall objective. An activity system is a set of interdependent organizational activities centred on a focal firm, and encompasses activities that are conducted either by the focal firm or by partners, customers or vendors. To fully address the market opportunity, the firm’s activity system may transcend the focal firm and span across the firm and its industry boundaries but remain firm-centric to enable the focal firm not only to create value with its partners, but to appropriate a share of the value created for it.

Interdependency among the business model activities is central to the view of the business model as an activity system. Interdependencies provide insights into the processes that enable the evolution of a focal firm’s activity system over time, as its competitive environment changes (Siggelkow 2001, 2002). Business models are created by entrepreneurs or managers who shape and design organizational activities as well as the links (transactions) that weave activities together into a system. Such purposeful design – within and across firm boundaries – is the essence of the business model (Zott and Amit 2009). Some activities relevant to the focal firm’s business model will be performed by the firm itself, others by suppliers, partners and/or customers. The architecture of the firm’s activity system – shaped by the choice of activities, how they are linked and who performs them – captures how the focal firm is embedded in its ecosystem, that is, in its multiple networks of suppliers, partners and customers.

The firm’s revenue model also plays an important role in value appropriation. The revenue model, akin to a pricing strategy for specific products or services, refers to the specific modes in which a business model enables revenue generation (Amit and Zott 2001). In that sense, a revenue model complements a business model design, just as a pricing strategy complements a product design. Although the concepts may be quite closely related and sometimes even intertwined – for example, in the product world, Gillette uses its pricing strategy of selling cheap razors to make customers buy its rather expensive blades – business models and revenue models are conceptually distinct.

A business model is geared towards total value creation for all parties involved. It lays the foundations for the focal firm’s value capture by co-defining (along with the firm’s products and services) the overall ‘size of the value pie’, or the total value created in transactions, which can be considered an upper limit to the firm’s value capture. The business model also co-determines the focal firm’s bargaining power. The greater the total value created and the greater the focal firm’s bargaining power, the greater the amount of value that the focal firm can appropriate (Zott and Amit 2007).

Business Models and Strategy: A Review of the Literature

A recent review of the business model literature by Zott et al. (2011) found that the business model is often studied without explicitly defining the concept. Moreover, existing definitions sometimes only partially overlap. The selected business model definitions table summarizes some of the most prevalent definitions (Table 1).

Business Model, the, Table 1 Selected business model definitions
Full size table

Why has scholarly interest in business models surged? The increasing importance of digital technologies is part of the answer. They have provided firms with the ability to experiment with novel forms of value creation mechanisms, which are networked in the sense that value can be created in concert by a firm and a plethora of partners, for multiple users. According to Hamel (2000), companies must develop new business models, in which both value creation and value capture occur in a value network, which can include suppliers, partners, distribution channels and coalitions that extend the company’s resources. This has attracted the attention of management scholars, who have developed the concept of the business model in their attempt to explain value creation in networked markets (e.g., Zott and Amit 2009). Value creation mechanisms thus often go beyond the value that can be created through Schumpeterian innovation, the (re-)configuration of the value chain (Porter 1985), the formation of strategic networks among firms or the exploitation of firms’ specific core competencies. As Amit and Zott (2001) observe, prior frameworks used in isolation cannot sufficiently address questions about total value creation. Based on a sample of 150 firms, they propose four potential sources of value creation through business models: (1) novelty, (2) lock-in, (3) complementarities, and (4) efficiency. These value drivers can be mutually reinforcing; that is, the presence of each value driver can enhance the effectiveness of any other value driver.

While some of the literature on the business model tends to concentrate on value creation through the firm’s activities with its network of partners, increasingly, scholars are acknowledging that firms do not execute their business models in a competitive vacuum, and that firms can indeed compete through their business models (Casadesus-Masanell and Ricart 2010). The business model, then, represents a potential source of competitive advantage (Markides and Charitou 2004), one that is distinct from the firm’s product market position (Christensen 2001; Zott and Amit 2008). The novelty presented by new effective models can result in superior value creation, and replace the old way of doing things to become the standard for the next generation of entrepreneurs to beat (Magretta 2002).

Business models can thus play a central role in explaining firm performance. Afuah and Tucci propose the business model as a unifying construct for explaining competitive advantage and firm performance and define it as ‘the method by which a firm builds and uses its resources to offer its customer better value and to make money in doing so’ (Afuah and Tucci 2001: 3). Afuah (2004) focuses on firms’ profitability and introduces a strategic framework in which the business model is conceptualized by means of a set of components that corresponds to the determinants of firm profitability.

While the work of Afuah (2004) and Afuah and Tucci (2001) is conceptual, some authors have conducted empirical analyses. Zott and Amit (2007) have analysed the performance implications of business model designs by looking at two distinct effects: the total value creation potential of the business model design and the focal firm’s ability to appropriate that value. Zott and Amit (2008) examine the possible contingent effect of business model design in mediating between product market strategy and firm performance. They ask how the firm’s business model and product market strategy interact to impact the firm performance. They find that: (1) business model designs that emphasize novelty and that are coupled with either differentiation or cost leadership strategies can have a positive impact on the firm’s performance, and (2) novelty-centred business models together with early entry into a market have a positive effect on performance. Thus, business model design and product market strategy are complements, not substitutes (Zott and Amit 2008).

Other studies on the performance implications of business model design come from business practitioners and consultants (e.g., Linder and Cantrell 2001). Consultants at IBM (2006), interviewing 765 corporate and public sector leaders worldwide, for example, found that firms that were financial out-performers put twice as much emphasis on business model innovation as underperformers.

So how does the business model relate to strategy? In our view, the business model extends central ideas in business strategy and its associated theoretical traditions. Two main differentiating factors seem to have captured the attention of scholars. The first is the traditional emphasis of strategy on competition, value capture and competitive advantage, whereas the business model concept seems to focus more on cooperation, partnerships and joint value creation (Magretta 2002). The second factor of interest to strategy scholars is the focus of the business model concept on the value proposition and a generalized emphasis on the role of the customer, which appears to be less pronounced elsewhere in the strategy literature. A consensus seems to have emerged that the business model revolves around customer-focused value creation (Chesbrough and Rosenbloom 2002; Teece 2007, 2010; Zott et al. 2011). Viewed from this perspective, the business model outlines the essential details of a firm’s value proposition for its various stakeholders as well as the activity system the firm uses to create and deliver value to its customers (Seddon et al. 2004; Zott and Amit 2010).

Despite the highlighted conceptual differences between business models and certain aspects of firm strategy, scholars have also emphasized that the business model can play an important role for a firm’s strategy. According to Richardson (2008), the business model explains how the activities of the firm work together to execute its strategy, thus bridging strategy formulation and implementation. In a similar vein, Shafer et al. (2005) and Casadesus-Masanell and Ricart (2010) view the business model as a reflection of a firm’s realized strategy. According to Teece, the business model reflects a ‘hypothesis about what customers want, and how an enterprise can best meet those needs, and get paid for doing so’ (Teece 2007: 1329); it ‘embodies nothing less than the organizational and financial ‘architecture’ of the business’ (Teece 2010: 173).

Opportunities for Future Research

Research on business models needs to be advanced through both theory development and empirical analysis. Increasing consensus on the theoretical foundations, the definition and the fundamental properties of business models could lead to the emergence of broadly accepted typologies, which are currently lacking. Further research on the relationship between the activity systems and revenue models of firms is needed to extend both theory and practice. Such research will help deepen our understanding of the linkages between value creation and value appropriation. Empirical research on the measurement of business model design, structured to capture all lines of a firm’s business that have revenue potential, holds great promise to enhance our understanding of business models. Examining the dynamics of business model evolution, how they emerge, and how they are shaped and adapted over time, as well as how business models co-evolve with strategy and organization design reflects an important research programme that will substantially solidify the business model as a pivotal concept in our understanding of value creation and capture.

In summary, we are still in the early stages of identifying and evaluating the business model as a new unit and level of analysis for strategy research. Theoretical, empirical and field research on the foundations and evolutions of business models promises to broaden our understanding of this important concept.

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