Killing Two Birds with One Stone

Profit for Now and Learning for the FutureHiroyuki Itami and Kazumi NishinoA business model is commonly seen as composed of two elements: a business system anda profit model. While the latter often gains the higher profile, the former is arguably thereal meat of a firms business model. Not only does it act as the system of works thatactually produces and delivers the firms products or services, it is also the locus wherea firm can learn about its operations and the behaviors of its suppliers and customers. Thislearning can accumulate to represent a considerable competitive advantage, one that risksbeing wasted if activities are unwisely unbundled. While the profit model earns revenuesfor the short term, the business system learns information for the longer term: a successfulbusiness model must aim for both these outcomes. 2009 Elsevier Ltd. All rights reserved.A business model e a model plus a systemAlthough the term business model is defined in various ways by different authors, the commondefinition seems to be that a business model is composed of two elements, a business systemand a profit model, hence the term business model. A business system is the system of works(the production/delivery system) that a firm designs within and beyond its boundaries to deliverits products or services to its target customers. A profit model is a pattern of the firms intentionabout how it will make a profit in its given business, i.e. how it plans to increase sales and/or reducecosts. Or, put another way, a firms profit model is a model of its strategic intent to achieve variouskinds of differentiation from its competitors (by product or price, etc.), while its business system isa system designed to realize that strategic intent. Good intentions to persuade customers will notbear real fruit unless they are backed by actual systems of works that really impact the customer.But, while many see a firms business system as this delivery system alone, there is much moreto it e it is also a learning system. Figure 1 illustrates a simple version of the layout of theseelements. In this note we emphasize the importance of the business system, and explain how itsrole as the firms learning system is central to its success.Long Range Planning 43 (2010) 364e369 http://www.elsevier.com/locate/lrp0024-6301/$ see front matter 2009 Elsevier Ltd. All rights reserved.doi:10.1016/j.lrp.2009.07.007To consider Google as an example: a particular characteristic of Googles profit model is that theusers of its service(s) never pay a penny to the provider firm e what they do instead is provide theopportunity for Google to capitalize on their presence on its search engine site by selling site spaceto advertisers, who are the source of the firms revenues. To increase these advertising sales, Googleneeds to increase the usage of its search services, to offer its advertisers increasing opportunities tomake contact with Google users to deliver their messages. Another aspect of Googles profit modelis their efforts to reduce the costs of providing the free of charge search services to its users, and torealize that strategic intent, Google has not only developed various bespoke in-house software elements,but has also invested in a huge in-house server system to cut the costs of providing its widerange of search services.1 Taken together, these software and hardware capabilities represent themain body of the Google business system. From the moment the user enters the Google portal,this in-house business system processes not only the users search requests, but also the potentialamount of contact each advertiser has with users, and thus calculates the firms charges to its advertisers.Users are attracted to Google because its system functions very quickly, and can handlegreat volumes of information, and this wide user base attracts advertisers: without this businesssystem, Googles profit model would never work. But the system also allows Google to learnmore about its business. By gathering information about patterns of use of its services, it allowsGoogle to monitor changes in these patterns, and thus anticipate next generations of services itmight provide, or, indeed, services it provides which its users do not value and are in decliningdemand.The business system less visible but more important?Of the two business model elements, the profit model is the more visible, not only because it isusually what outsiders can observe, but also it is the more glamorous, due to its direct link tothe firms bottom line. Perhaps for that reason, much of the discussion about firms businessmodels tends to focus on their profit models. But the business system is more often the realmeat, because it performs twin roles first as the system that does the real work in terms ofrealizing a firms strategic differentiation intent,2 and secondly in accelerating its learning for thefuture.In designing its business system, the firm usually has to determine the following three things:(1) the division of labor between the firm and its trading partners (typically a decision betweenoutsourcing and internal procurement) (2) internally, how should the firm organize its[While] the profit model is more glamorous, being directly linked to thebottom line. the business system is the real meat e doing the firmsreal work [and] accelerating its learning for the future.InternalExternalBUSINESSMODEL = DeliverySystemBusinessSystem+= +ProfitModelLearningSystemFigure 1. Basic Business ModelLong Range Planning, vol 43 2010 365in-house working system and (3) externally, how it should control the activities of its tradingpartners.Toyotas famous (and much-copied) business system is exceptional in all three aspects. Toyotaoutsources production of many of its auto parts (many more than GM, for example) but oftenpractices tapered outsourcing in vital parts in three senses. First, Toyota often both outsourcesand produces the same parts in-house simultaneously. Second, its outsourcing strategy involvesavoiding procuring from only a single supplier e typically it uses 2e4. Thirdly, Toyota maintainslong, continuous relationships with a limited numbers of suppliers, in what are often known as keiretsurelationships.3 These are not textbook, arms length relationships, but semi-organizational relationshipsof mutual trust based on a long-term perspective of common interests.4 Toyotasfamous Toyota Production System thus functions as both as an internal system of organizingwork and an external mechanism to control its suppliers. The system is not only a physical systemof parts and assembly flows, but also a very delicate information system conveying various operatinginformation both in-house and with suppliers in other words, both physical object and informationflows occur in a synchronized manner through various unique system features, such asthe Kanban system. Tapered outsourcing also functions as an external control system, as the companycan get technology and cost information from both its own in-house production of parts andfrom its plural (and competing) outsourcing suppliers. Toyota also arranges various forums forcomparing costs and technologies among its suppliers, which again both represent opportunitiesto exchange various items of information with its outsourced elements and reinforce competitionbetween them.Doing is learningBoth Googles and Toyotas business systems function not only as systems of works to satisfy theircustomers needs better than their competitors, but also as systems for people in their organizationto learn more about their technology, their customers reaction etc. A business system functions asa learning system because doing the work involves learning about the work and doing also leavesthe doers footprints. The business system determines two factors: first, the elements of the entirework flow that are to be done in-house to deliver the product to the customer (and thus thosewhich are to be outsourced) and, second, the information system that operates and controls theentire work flow from both in-house works and outsourced operations for final delivery to the customer.These two factors influence how the firm learns, both about its technology and its market(s).First, when people actually do work, information of various kinds flows to and from them, becausehuman beings have high observational and thinking capacities that are stimulated by the actof doing e and the act itself also provides trigger events that activate this capacity.5 Second, thebusiness system accumulates information. Doers (workers who work, suppliers who supply or customerswho buy) leave footprints of their actions e and as electronic information about the detailsof work, of supplier behaviors and customer purchases flows into the firms information system,each bit can be collected and learnt from, and this learning accumulates to form a valuable databasefor the firm for its future.For example, by designing their own software and operating their server system in-house, Googlecan get accumulate information both on how to improve its software and data on the patterns of itsusers Internet search behaviors (such as links between websites). In the Toyota case, Toyota canlearn about both the technology and cost of auto parts production in various ways through theway its business system is set up, from producing a portion of necessary parts in-house or via itsdaily contacts with its long-term suppliers.So a business system is not just a system of mundane operations that determines the cost of operationsand products e it can also act as a learning system for the firm. And if it is designed so thatpeople within the firm do much of the information-rich work themselves and/or if it enables thefirm to observe at close range how outside parties (including its customers) act the information(of various kinds) the firm gains as a byproduct of its business system activity can accumulate quitequickly, and can grow to become very important for its long-term health.6366 Killing Two Birds with One StoneThe essence of this information accumulation is very simple. If you do a work activity yourself,you can learn many things associated with the task e but if you let others do the work, and merelybuy the outcome, you allow them to learn, and learn nothing yourself. And since this learning (orinformation accumulation) is a byproduct of tasks that somebody has to do anyway, a properly designedbusiness system should allow for firm learning with little extra cost. If firms can get to theposition (like Google and Toyota) where their business expansion means doing more within (orclose to) the firm, and that leads to more information accumulation at little extra cost, this learningcan be developed into a huge competitive advantage. Figure 2 shows the learning flow elements associatedwith the business system.The traps of unbundlingOne of the buzzwords in the business model discussion from the late 1990s through the first decadeof this century was unbundling7 and the open innovation that was supposed to flow from this strategy.8 As a profit model, unbundling has many attractions e if the contracting firm offers a low-costoperation it can be a good way to reduce operating costs for the unbundling firm, which, since it nolonger has to invest in this sector of work, can also reduce its capital costs. However the story maynot end there the business system side of the business model has also to be considered. If the doer isthe one who accumulates information about the work, it will be the contracting firm that learnsinstead, and the unbundling firm will become less educated about the work it is no longer doing.The costs of the control of the unbundled e now external work become an additional load onthe unbundling firms business system, since it must now integrate the bundled and unbundledworks together to have a smooth overall operation to deliver the final product to the customer.This may not be a serious problem, providing the bundled and unbundled works can be integratedtogether smoothly without transaction costs becoming too expensive, and if learning lessabout the work does not erode the future growth potential of the unbundling firm: in such casesthe profit model merit of unbundling can override the risks to the business system.But the world we live in is not always so harmonious. Environmental conditions in supplier firmsmay change dramatically, threatening supply lines or otherwise destabilizing smooth integration inways the focal firm cannot control and which make nonsense of the choice to unbundle. And,perhaps more significantly, learning by producing a certain component in-house may providea huge potential in a future market where that component occupies a central role in a successfulnew product. Sharp, the undoubted Japanese leader in liquid crystal display (LCD) TV, beganInternalExternal CurrentCore InvisibleAssetsFutureCore InvisibleAssetsLearningLearningDeliverySystemBusinessSystem = +LearningSystemFigure 2. Dynamics between Business System, Learning and Core Invisible Assets.doing a work activity yourself, you learn many things e if others do it,[they] learn, and [you] learn nothing yourself.. a properly designedbusiness system can allow for firm learning with little extra cost.Long Range Planning, vol 43 2010 367internalizing production of LCD components for their calculator business over 30 years ago, accumulatinglearning about LCD technology through producing. It wasnt until 15 years later it decidedto capitalize on this learning to start developing LCD TVs e but it could never have goneon to become the leader in this huge market if it had unbundled LCD component production30 years earlier. What may have appeared a minor business system decision at the time fundamentallyaffected the firms future growth path.In a sense, the traps of unbundling are traps in the market mechanism itself. Perhaps one of thereasons why unbundling has been so popular over the last 15 years was peoples unconscious beliefin the efficacy of the market mechanism and capitalism following the demise of communism. Freetrading and markets were in planning and organization were out. With hindsight, unbundlingcan, perhaps, be seen as a symbolic example of these trendy thoughts in the business models field.Core invisible assets and the business systemWarning against too much unbundling does not mean firms should internalize everything theremust be a limit, and that limit determines the boundary of the organic economic body called afirm. Each firm should decide its boundaries taking into account what it can do better than otherfirms, i.e. its core competence or core invisible assets.9 The boundary of the firm, what it does insideits boundary, and how it relates to other firms outside its boundary e these three things togetherdetermine the identity of the firm, and are at the core of its business system design. In effect, thebusiness system determines the identity of the firm, and its core invisible assets should be amongthe central elements of its business system design. However, the relationship between a firmsbusiness system and its core invisible assets is also dynamic. A firm will decide on the design ofits business system at a certain point in time, and that design then determines the learning potentialof the firm from the work it does and the information that flows into its system on a daily basis. Thebusiness system is largely dependent on the firms current core invisible assets e but the currentbusiness system design will, to a great extent, determine the future core invisible assets (see againFigure 2). As supplier and customer markets change and the business environment alters, thebusiness system adapts to those variations by capitalizing on the core invisible assets of the firmat that time. But, to be able to compete more effectively, or to enhance its range, the firm mayhave to embark on a new business system that involves elements somewhat outside its currentcore capabilities. The daily operation of a business system designed in the way we have illustratedallows for new learning that can modify firm capabilities to meet new challenges. And this new setof assets will again affect the future business system, so the circle of influence between the twocontinues. This dynamism is one of the fundamental reasons why we emphasize the business systemas being the real meat of a firms business model.learning by producing a component in-house may provide a hugepotential if it occupies a central role in a successful future product..current business system design will determine future core invisibleassets [in a dynamic relationship].[its] daily operation allows for newlearning to modify firm capabilities to meet new challenges.368 Killing Two Birds with One StoneConclusionCertainly, the profit model is very important, since it is the model that provides the firm withmoney, at least in the short term. But this has led its importance to be over-emphasized thefirm as a going concern has to aim for future growth potential, too, and so managers need tolook for both profit opportunities for the short-term and learning potential for the long-term. Indiscussing the business models for the future, aiming for two birds with one stone seems to bea must.AcknowledgementsThe authors thank the Special Issue editors Charles Baden-Fuller and Ian C. MacMillan for theirinvitation to contribute to the issue, and for their advice and encouragement during the process.References B. Iyer and T. H. Davenport, Reverse engineering googles innovation machine, Harvard Business Review,(April 2008) for example, explain this huge investment in detail.For the construction of a business system to realize differentiation intent, see R. G. McGrath and I. C. Mac-Millan, Market busting: strategies for exceptional business growth, Harvard Business Review (March 2005).See, for example D. Ge and T. Fujimoto, Suppliers involvement in new product development in theJapanese auto industry a case study from a product architecture perspective, in C. Herstatt, C. Stockstrom,H. Tschirky and A. Nagahira (eds.), Management of Technology and Innovation in Japan, Springer, BerlinHeidelberg, 235e248 (2006).

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