Wharton@Work

March 2023 | Strategy

Is Your Business Model Holding You Back?

Eighty-five percent of executives recently polled by McKinsey said innovation efforts were held back often or always by one factor: fear. The cost of developing a new technology, product, or service (in terms of capital, time, and opportunity); the uncertainty; and the high failure rate work together to prevent leaders from making the investment. And yet the pressure to “innovate or die” is growing. If you’re feeling stuck between these options, Wharton’s Dhirubhai Ambani Professor of Innovation and Entrepreneurship Serguei Netessine has some good news. There is another way.

“Innovation doesn’t always require new technologies or products. Instead, you can create significant value — and even disruptive competitive advantage — by innovating your business model, improving the way you leverage the same products or services that your customers are already consuming,” says Netessine. “One of its biggest advantages is that it's easy and cheap to come up with ideas. Eventually you will need some money to run pilots and experiments to test those ideas, but that's usually not very expensive, especially when compared to the billions of dollars that companies set aside for R&D.”

Another advantage is that business model innovations are typically very difficult, if not impossible, to copy. That’s because they focus on adjustments that leverage your existing products, markets, and infrastructure and are often not obvious to your competitors (unlike, say, a new model of iPhone).

But if it’s that easy, inexpensive, and effective, why aren’t more organizations innovating their business models? According to Netessine, the roadblocks go beyond the fear identified in the McKinsey survey. “You have to look at your culture and the mindset of your senior leaders. Innovation requires changing your tolerance to risk, envisioning new KPIs, identifying the right stakeholders, and thinking about different skill sets that people need to create and implement new business models.” In other words, you need organizational and cultural change, which is why about half of the Business Model Innovation in the Age of AI program, which Netessine directs, is devoted to change management.

“The program attracts a great mix of people, some who realize they need innovation and want to learn about how they can innovate their business model. On the other end of the spectrum, we get people who are actually going through the process now and are running into all the familiar barriers, including how they can start thinking about changing their organization. They realize that is their biggest impediment, and we help them address it.”

He says resistance is especially strong in big companies that are not comfortable with experimentation. “They may happily exist with the same business model for a hundred years, believing nothing is going to change. They view the status quo as the safest thing to do because if you innovate, who knows what will happen? But what they don’t consider is that the status quo is not costless. There is a big potential cost of being out-competed by other companies with better business models.”

Future-proofing your organization

While some industries move a little faster than others, Netessine says “over time we have seen that even the slowest moving, like banking, have had to change their business models. They went from saying, ‘That's not going to touch me,’ to realizing that fintech is here to stay and they have to adapt. There are companies that are acquiring their customers very, very quickly. It may be a little bit slower than in the computer industry or social media, but this kind of disruption will happen in every industry. Expect new players using new technologies and new business models who will disrupt existing players.”

The speed of change isn’t just industry-dependent, though. Size matters. “It’s often the big companies that are slowest to change,” says Netessine. “They have the money, the resources, and the existing customers, so they're well positioned to innovate. But most of the time, they don't start looking for a solution until the situation becomes really, really bad. And at that point, it's usually too late. When your back is against the wall, you don't have time to conduct proper experiments, so you just do one experiment and bet your entire company on it. Very often it fails. The best time to review your business model and innovate is when you are doing well, when you are healthy, and when you are generating good profit margins.”

Making pivots possible

“Getting in the habit of transforming your business model, or continually rethinking it, lets you be nimble,” he continues. “You're future-proofing the organization because you don't know what the next disruption will be. If you're already in this mindset and you've put your status quo aside, you're better able to pivot no matter what happens.”

“We saw this very clearly with COVID. It was not anything that anyone was prepared for. But the companies that had the capability to experiment very quickly tried different business models. Others, like many retailers, just shut down and planned to wait it out. But nobody can survive being shut down for two years. More innovative retailers began offering curbside pickup, expanding delivery, partnering with Instacart, and experimenting with many, many other business models,” says Netessine.

“To come to these kinds of counterintuitive decisions, you need to conduct a portfolio of experiments with different business models. By launching those experiments, you see which ones work and which ones don't. Typically, most innovations fail, which is very difficult for a big company to cope with. It’s not something people are usually rewarded for, and it’s a very difficult frame of mind to change. You have to find ways to support your employees so that they are free to experiment and fail. You should fully expect that only one experiment out of 10 will actually give you something interesting, some potential for a new business model. And that's an organizational change that needs to accompany business model innovation.”

What does it look like?

Where do ideas for business model innovation come from? Netessine says the answer varies. “For B2C companies, being close to your customers helps because you will pick up on changes that can inform how you might innovate your business model. Customers now consume information differently, for example. They used to read print advertising, but now use different channels, which can be a source of innovation. For B2B companies, there are business model innovations that are on the backend. So, you do have to listen to customers, suppliers, or partners to some extent, but that’s just one type of business model innovation.”

Netessine says innovation can also be on the operational side. “Making your business model much more efficient can be very powerful. The customer might not ever see that type of change. It's not limited to cutting costs, increasing revenues, or making life of customers easier. It can be a combination of those things, or even changing your entire value proposition, changing why people buy from your company.”

Business model innovation could also mean getting involved in an ecosystem or partnering with a competitor — decisions that can feel too risky. “Amazon at one point was just an online retailer,” says Netessine. “Then they invited anyone to sell on their platform while they did the fulfillment, customer acquisition, and advertising. It was a hotly debated decision. Lots of people said it was crazy for them to share their competitive advantage. But now about two thirds of Amazon’s revenue come from those third-party sellers. No one today doubts that it was the right decision.”

Responding to new technologies

The latest potential disruptors include Chat GPT and other AI and machine-learning technologies. But as Netessine stresses, responding with fear — believing your back is against the wall and you must act quickly — rarely works. “The reaction to Chat GPT is the same one other new technologies have received. People fear that it will displace certain jobs and certain companies. One of the key learnings in Business Model Innovation in the Age of AI is that technologies don't really do that.”

“What really happens is that after the hype, some new technologies find a good business model. But many of them don't. Google Glass is a great example. After all the publicity, where is it now? Is anyone using Google Glass? Have you seen it? Today most people don’t even remember what it is.”

He says Chat GPT is similar. “Everybody's talking about it, but over time it has to find a business model. That’s when companies can get displaced. During the program, we discuss various business models that might use Chat GPT. When companies learn how to commercialize it, how to use it, how to make money from it, that's what can change the world. It’s not the technology itself. Any company can think about creating a business model based on Chat GPT — it’s a technology that is freely available.”

“The question you need to ask isn’t how can you protect yourself against the threat of new technologies, innovations, and competitors. Ask what you’re going to do about it. How can you use it to your advantage? The answers are in your next business model.”

Are you ready?

Netessine says you probably need to innovate your business model if you can’t answer a couple of simple questions: where does your company’s business model come from, and how long has it existed? “If the answer is, ‘I don't know,’ there is clearly something wrong with your business model,” he explains. “Customers change, technologies change, and consumer habits change. At least some part of your business model has to change as well. If you don't innovate it yourselves, somebody will come along with a better value proposition and out-innovate you. Entire industries can be destroyed by a different business model. We've seen it in almost every industry.”

“Essentially,” he continues, “the biggest fear that people should have is not the fear of experimentation and getting the experiment wrong, because the cost of that is relatively small. The worst case is that if it doesn't succeed, you will still learn something in the process that can inform future experiments. That's much more manageable than the potential cost of going bankrupt like the Blockbusters of the world. Sharing the fate of companies that didn't change their business model when it was warranted, like Kodak, should be your real fear.”