Article Summary: Why Business Models Matters

Joan Magrettas article Why Business Models Matter (HBR, 2002) highlights that the terms business model and strategy are different although they are the most sloppily and interchangeably used in businesses, thus rendering them meaningless. The author explains the importance of a business model, what causes it to succeed or fail and how it is complemented by a strategy through illustrative examples. Definitions: Differences between a Business Model and Strategy Magretta calls a business model a "story", it "describes how a company produces, delivers and sells a product or service to create wealth1 in other words it explains who your customers are and how you plan or intend to generate revenue by creating customer value. Strategy on the other hand is the differentiating factor that compliments the business model and helps it succeed. It rather helps businesses to beat competition by being different. Importance for a Successful Business The article emphasizes that the strength of a business model as a planning tool is its focus on how "all the elements of the system fit into a working whole". Entrepreneurial success calls for a good business model and a realistic one too. As Magretta puts it, A good business model answers Peter Druckers age-old questions: Who is the customer? And what does the customer value? The strategic analysis, explains how you will do better than your rivals. A good business model creates the space and gives room for businesses to test and revise the assumptions about their customers, thoroughly think about the business, accordingly organize staff to achieve the companys mission and change when necessary. Two Critical Tests Joan Magretta highlights two critical tests for the success of business models: 1. If the business model tells a logical story, shedding light on who the customers are, what they value, and how the business is going to earn by catering to them that value, it passes the narrative test. The storys design could add value in the business value chain in these two ways: 1) by delivering something that satisfies an
1 Laudon et a.l, 2010, Management Information System: Managing the Digital Frim, Eleventh Edition, Pearson
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unmet need, e.g. American Express travelers checks put travelers at ease and peace while traveling without having to carry hard cash and 2) by selling products and services innovatively, e.g. Eastern Exclusives distributes restaurant discount coupon books in bulk to university housing departments, which then distribute them free to the dorms. 2. A business model also has to pass the numbers test. A good story has

meaning only if assumptions about customers are tied up to sound economics. According to Magretta, a businesss profit and loss assumption must add up. The online grocery models mentioned in the article demonstrates an example of failure. As customers were unwilling to pay significantly more online than in the stores, the Egrocers could not make up for their marketing, technology, and delivery costs. The online auction giant eBay that combined a convincing narrative with huge profit potential is a successful business models the article talks about. This online business couldnt be done offline and still provide value to collectors, bargainers, and smallbusiness people. Although its' activities are constricted in scope its cost structure is highly profitable, as sellers and buyers manage payment and shipping logistics, there is neither an inventory or transportation costs nor credit risks for eBay. Why Business Models Fail? Business model fails for it has either failed the narrative or the number tests. They don't work; because the story does not any make sense and/or the numbers just don't add up to profits. Businesses at this point need to give a food for thought as to what needs to change for their business model to work. The EuroDisney story sets a clear example. They opened the Paris theme park under the assumption that Europeans like Americans prefer grazing all day at the parks restaurants but instead Europeans chose to eat meals at the same time, resulting in overloaded restaurants, long lines, and frustrated patrons. EuroDisneys model failed the narrative test as customers motivation was wrongly interpreted. Strategy Complements a Business Model However, a sound business model alone does not do the trick. It has to be backed by a strategy too; how a business plans on outstripping competitors by differentiating ones products and services and gaining the competitive advantage. The author uses

this example to explain. Wal-Mart used Kmarts business model, yet implemented a unique strategy of trying to be different than its rivals, promising different value to customers in different markets, setting up big discount stores into little one-horse towns that competitors ignored. Founder Sam Walton rightly assumed that if WalMart stores beat city prices by offering name brands (not second-tier /private-label brands), townspeople would shop close to home.