• Friday, March 29, 2024
businessday logo

BusinessDay

What is a business model?

Business model

In “The New, New Thing,” Michael Lewis refers to the phrase “business model” as a term of art. And like art itself, it’s one of those things many people feel they can recognize when they see it but can’t quite define.

A look through HBR’s archives shows the many ways business thinkers use the concept and how that can skew the definitions. Lewis himself echoes many people’s impression of how Peter Drucker defined the term — “assumptions about what a company gets paid for” — which is part of Drucker’s “theory of the business.”

Citing as a sterling example one of the most strategically nimble companies of all time — IBM — he explains that sooner or later, some assumption you have about what’s critical to your company will turn out to be no longer true. In IBM’s case, having made the shift from tabulating-machine company to hardware leaser to a vendor of mainframe, minicomputer and even PC hardware, Big Blue finally runs adrift.

Joan Magretta, too, cites Drucker when she defines what a business model is in “Why Business Models Matter,” partly as a corrective to Lewis. Magretta, like Drucker, is focused more on the assumptions than on the money, pointing out that the term “business model” first came into widespread use with the advent of the personal computer and the spreadsheet. A business model, she says, has two parts: “Part one includes all the activities associated with making something: designing it, purchasing raw materials, manufacturing, and so on. Part two includes all the activities associated with selling something: finding and reaching customers, transacting a sale, distributing the product, or delivering the service.”

Once you begin to compare one model with another, you’re entering the realms of strategy, with which business models are often confused. Magretta goes back to first principles to make a simple and useful distinction, pointing out that a business model is a description of how your business runs, but a competitive strategy explains how you will do better than your rivals.

Introducing a better business model into an existing market is the definition of a disruptive innovation. Knowing you need one and creating one are, of course, two vastly different things.

written by Andrea Ovans,a senior editor at Harvard Business Review