Business Model Generation, by innovation experts Alexander Osterwalder and Yves Pigneur, is a contemporary guide to systematic business innovation. We’ll look at the book’s basic template, the most successful business model formulas, and strategies to create or optimize your existing business model.
(Shortform note: Many experts agree that the average lifespan of successful business models has fallen to less than five years. Therefore, to achieve a sustainable competitive advantage, businesses need to continually evaluate and redesign their business models.)
Osterwalder and Pigneur developed a flexible template, which they refer to as the “Business Model Canvas,” to help you understand and focus on the nine overarching elements that they believe make up any successful business model. The template offers a visual framework to describe, assess, update, or design business models. You can use it to analyze the strategies of your competitors, to evaluate or to create new strategies for your existing business, or to design an entirely new business.
(Shortform note: The Lean Canvas is a popular adaptation of the Business Model Canvas. Developed by Ash Maurya, the author of Running Lean, it’s designed specifically for action-orientated start-up companies that rely on continuous experimentation to develop their products and services. Consequently, it places more emphasis on defining customer problems and identifying competitive solutions.)
Osterwalder and Pigneur encourage you to consider each of the nine elements as interdependent components that impact the effectiveness of the other elements. In other words, changes to one element can impose constraints or amplify the effects of other elements. Therefore, as you work on your business models, consider how you can leverage all of your elements to work together.
Define the different groups of customers your business intends to target—Osterwalder and Pigneur refer to this element as “Customer Segments.” You may serve one group of customers or several groups of customers depending on the needs you intend to fulfill.
The Four Steps to the Epiphany by Steve Blank emphasizes the importance of identifying and validating your customer groups before you develop your business model. The book includes a four-step customer development process to help businesses effectively define and target customer groups.
Define your touchpoints, how you’ll communicate with your customers and deliver your products and services—Osterwalder and Pigneur refer to this element as “Channels.” For your communication, sales, and distribution, you have the option of using your own touchpoints (assets under your direct control such as your website or your store), or partner-owned touchpoints (external touchpoints that result from cooperation with marketing agencies or distribution partners), or a mix of both. In addition, the authors also make a distinction between direct touchpoints (communication you control such as your blog), and indirect touchpoints (communication you can’t control such as user reviews).
Touchpoints and Interactions (Element 3) are closely linked—consider the level of interaction you want to have with your customers when defining your touchpoints.
Businesses tend to assume that more touchpoints will lead to more customers, so they work hard to create multiple interaction points across the five stages. However, research indicates that too many touchpoints can reduce the quality of service that you deliver and damage customer experience. Customers care more about the quality of service you provide than what touchpoints you use—you’re more likely to create successful channels if you prioritize the development and integration of fewer touchpoints.
Define the type of interactions you want to establish for each of your customer groups—Osterwalder and Pigneur refer to this element as “Customer Relationships.” The authors advise that you consider what your motivations are for communicating with your customers as your approach will differ depending on whether you intend to acquire new customers, retain existing customers, or upsell to existing customers.
Brand relationship experts have identified 29 different types of interactions that customers expect from a business—they use relationship metaphors such as “one-night stand” or “marriage” to clearly define each interaction. These experts argue that businesses can’t understand or leverage customer relationships unless they collect and analyze the relationship signals their customers send.
Define how you intend to offer value to these customers—Osterwalder and Pigneur refer to this element as “Value Propositions.” Your value offer outlines the benefits you intend to provide in the form of products and services. The authors state that successful value offers align with the needs of your customers and differentiate themselves from existing solutions.
Businesses often associate value creation with competition—they assume that they need to offer something that outperforms and displaces what’s currently on the market. However, Sesame Street, life coaching, and Viagra all prove that it’s possible to create innovative products and services without disrupting existing markets. Instead, the businesses behind these products and services bypass competition by focusing on creating demand in entirely new marketplaces.
Define what resources you need to create and deliver your products and services to your customer—Osterwalder and Pigneur refer to this element as “Key Resources.” According to the authors, you can own, lease, or acquire the resources you need. All resources fall into the following categories: material, monetary, intellectual, and human.
This method often highlights the need to acquire more resources before you can move forward with your business model. However, some businesses approach this in reverse: They use their resource limitations to inspire product and service innovations. For example, Southwest Airlines used its resource constraints to reposition its offering and become one of the most profitable airlines in the industry.
Define the alliances you need to form to optimize your business model and increase market share, acquire resources, or reduce risk—Osterwalder and Pigneur refer to this element as “Key Partnerships.” In other words, what alliances will provide you with a sustainable competitive advantage and help you to grow quickly?
One innovation expert compares strategic alliance relationships to marriage—like marriage, many strategic alliances fail to live up to expectations. In other words, both suffer from a high failure rate. However, the expert argues that strategic alliances are more likely to succeed if businesses focus on creating strong foundations built on shared values and mutual benefits.
Define the core actions you need to take to operate successfully and meet customer demands—Osterwalder and Pigneur refer to this element as “Key Activities.” The authors state that your actions will fall into the following categories: production (designing, manufacturing, and delivering products), troubleshooting (finding solutions to problems), and infrastructure management (managing interactions between multiple applications and parties).
Osterwalder and Pigneur don’t provide practical advice here since different business models rely on different activities to operate successfully. Measure What Matters provides an effective goal-setting process that you can use to define the objectives and key results for each of your business model elements. For example, if your objective is to acquire X number of customers in each customer group, your key results could be growing platform visitors by 5% every month and increasing organic traffic by 10% every six weeks.
Define how you intend to profit from the value you provide to your customers—Osterwalder and Pigneur refer to this element as “Revenue Streams.” The authors state that there are two types of income streams to consider: profits from single transactions and profits from ongoing payments such as subscriptions. You may have multiple income streams for each of your customer groups. Further, each of these income streams may involve different pricing mechanisms depending on whether you choose to set a fixed or variable price for your products and services.
How should you determine the price for your products and services? Many businesses determine their prices using the cost-plus method—calculate the costs involved and add on a percentage (desired profit). However, experts argue that businesses need to consider how much value customers attach to their products and services before they determine their prices.
Define the expenses of operating all of the elements you’ve defined in your business model—Osterwalder and Pigneur refer to this element as “Cost Structure.” Your expenses will vary depending on whether you choose to minimize costs and offer an inexpensive product or service, or if you choose to create premium-priced products and services. The authors state that your cost structures will include at least one of the following characteristics: fixed costs (salaries, rent), variable costs (costs that vary in proportion to the volume of goods or services produced), economies of scale (bulk purchase rates lessen cost per unit), and economies of scope (a single resource or activity supports multiple operations or services).
(Shortform note: All of your costs will also fall into the following categories: direct costs and indirect costs. Knowing the difference between these costs will help you to identify your overall business expenses.)
Osterwalder and Pigneur argue that the nine elements can combine into distinct patterns to create specific outcomes. To illustrate this, they present patterns they claim are common across all successful business models—a single business model can include several of these patterns. Once you familiarize yourself with these patterns, you’ll understand how the combination of certain elements can create dramatically different results, and you’ll be better prepared to manipulate the elements to successfully position your business.
(Shortform note: The Business Model Navigator presents an alternative way to approach business model patterns—it offers 55 patterns that you can pick and choose from, manipulate and combine to suit your needs. This method may be more suitable for established businesses that seek to innovate existing business models.)
Unbundled businesses split up (“unbundle”) their operations into three distinct business categories to increase efficiency: product innovation, customer relationship management, and infrastructure management.
Some business experts argue that businesses that offer services in one or more of these distinct categories can’t operate efficiently unless they unbundle. Further, they advise that businesses should focus only on one of these categories as their core service, and outsource the rest to specialized companies. As long as more than one of these activities coexists on a single business model, each of the elements will include conflicting priorities that will create limitations or “tradeoffs” across the business.
Businesses Focused on Product Innovation:
Businesses Focused on Customer Relationship Management:
Businesses Focused on Infrastructure Management:
Osterwalder and Pigneur refer to the recommendation from management experts that companies should narrow their business focus on delivering superior value in line with one of three “value disciplines”: product leadership, customer intimacy, or operational excellence. These value disciplines complement the three business categories and support the argument to “unbundle” the services.
Interestingly, companies that focus on the same value disciplines display similarities in the way that they operate, regardless of their industry. For example, the operating structures and workplace cultures of Federal Express and Walmart are almost identical because they both pursue operational excellence.
Long Tail businesses focus on creating a wide variety of diverse niche products and services for interested buyers—individually, each of these products sells very little, but the combined sales of all of the products generate high revenues. These models require cost-effective ways to manage large inventories, reach potential buyers, and facilitate transactions. Osterwalder and Pigneur suggest the following layout for Long Tail business models:
Book Publishing: From Mainstream to Long Tail
The Long Tail formula seems to fly in the face of the common advice to focus on a single niche product or service (in other words, to prioritize one thing and do that thing exceptionally well). Further, expanding your offerings according to the Long Tail formula could be the key to disrupting the market and winning big. Changes in the publishing industry are a great example of this.
Traditionally, publishers had to print and distribute books to bookstores before they could sell them. This incurred heavy printing, inventory, and distribution costs. Publishing houses were responsible for managing the editorial, marketing, production, and distribution costs for each title they published. In addition, brick and mortar bookstores had limited shelf space to stock books. Therefore, the majority of bookstores stocked only the bestselling titles.
Amazon’s long tail model disrupted this model in two ways. First, it made more books available to customers through Amazon Marketplace. Second, it allowed authors to self-publish their own books through Amazon Kindle Direct Publishing (KDP).
Amazon Marketplace isn’t restricted by shelf space or inventory costs—print-on-demand facilities allow them to store books as electronic files instead of hard copies. Amazon creates demand by displaying customer reviews and facilitates the purchase of these books. More than half of Amazon’s book sales come from books that aren’t sold in traditional bookstores—Amazon created a new market based on books customers actually want.
Additionally, Amazon KDP doesn't have to cover the editorial or marketing costs for self-published books. Millions of authors use Amazon KDP to self-publish books, and while they don’t sell every one of these books, the aggregate sales of all of the books allow Amazon KDP to thrive.
Multi-Sided Platforms provide an infrastructure to enable direct interaction between two or more different but interdependent groups of customers. This pattern is most obvious in a marketplace such as Etsy—this business facilitates exchanges between buyers and sellers, and it requires participation from both parties to offer value and operate successfully. In other words, if sellers stopped listing items on Etsy, customers would see no value in visiting the site. If customers stopped shopping on Etsy, sellers would see no value in listing their products. The more active users that a platform can attract, the more value it can offer to both parties.
Osterwalder and Pigneur suggest the following layout for Multi-Sided Platform business models:
Customer Groups: Focus on a minimum of two interdependent customer groups.
Value Offer: Value comes from the platform—it facilitates efficient and cost-effective interactions between the customer groups.
Profit Sources: Each group produces a different revenue stream depending on the fees they pay to use the platform (for marketplaces, sellers usually pay subscription fees while buyers have free access).
Critical Actions: Develop, maintain, and promote the platform to ensure it meets the needs of individual customer groups.
Network: Focus on developing partnerships that will make the platform more functional or attractive to all customer groups.
The Negative Impact of Network Effects on Sellers
As discussed, a multi-sided platform increases in value the more people use it. However, the more saturated these marketplaces become, the more difficult it is for sellers to stand out and attract the attention of buyers. Over-saturation of the platform creates a high risk of sellers moving to platforms with lower fees or access to different customer groups. Consequently, multi-sided platforms have to compete fiercely on both price and quality to keep their sellers from switching to competitor platforms.
The Free business model pattern ensures that at least one customer group always receives value for free. While different patterns make the model financially viable, Free users are always financed by another part of the business model or by another customer segment. Osterwalder and Pigneur categorize Free models into three groups, based on where their revenue comes from: advertising, premium services, and continuing purchases.
Multi-Sided Platforms encourage advertisers to subsidize free users. For example, the revenue that Google receives from advertisers enables Google users to make unlimited searches for free. The more free users, the more advertisers are willing to pay to access these users. Osterwalder and Pigneur suggest the following priorities for Free business models subsidized by advertising revenues:
Customer Groups: Focus on large customer groups to entice advertisers.
Value Offer: Value comes from providing a free product or service to customers. The resulting customer base will create value for advertisers.
Profit Sources: Profit comes from advertisers using the platform.
Critical Actions: Develop and maintain the platform to entice both customers and advertisers.
Network: Focus on developing partnerships that will make the platform more functional or attractive to all customer groups.
Facebook’s Advertising Revenue
Facebook has two primary groups of customers: Users, who they provide value for in the form of free communication, and advertisers, who they rely upon for revenue.
Facebook collects and analyzes data to categorize each of its users, then auctions off advertising space within users' feeds and stories based on these categorizations. Facebook has faced many accusations regarding the way it manages the security and privacy of its users. However, Facebook doesn’t sell personal data to advertisers—just advertising space based on user demographics. Still, the increasing scrutiny of the government and public demonstrates that applications of this Free model may need to change in the future.
Premium Service models—Osterwalder and Pigneur refer to these as “Freemium models”—give customers the option to use the basic service for free or to pay for premium or additional services. The revenue from paying customers supports the costs incurred by the free users. For example, Evernote offers three plans to users: free, personal, and professional, and users can choose to upgrade and pay if the free service doesn’t meet their needs. Osterwalder and Pigneur suggest the following layout for this type of business model:
The Difference Between Freemium and Free Trial
Both customer acquisition methods offer free services to customers. However, Freemium models provide “free value forever,” and this is more attractive to users than “free value for a limited time.” Consequently, businesses using Freemium models are more likely to grow their customer base at a much faster rate than businesses using Free Trials. However, the problem with Freemium models is that they create no sense of urgency for users to upgrade—converting free users to paying users can take months or years, if ever. Meanwhile, businesses have to pay to maintain and develop the services it offers to these users.
Continuing Purchases models—Osterwalder and Pigneur refer to these as “Bait and Hook” models—are characterized by cheap or free products that provide customers with instant gratification but create demand for future products and services. Although businesses initially lose money, they can easily cover the costs and make a profit from the recurring income they receive from these transactions. For example, coffee machines that require specific capsules to function can sell at a loss since customers will inevitably pay for the capsules so that they can use the machine. Osterwalder and Pigneur suggest the following layout for this type of business model:
Reversing the Model
Business models focused on continuing purchases generally offer the premium product (for example, coffee machine or printer) at a low cost and its complementary product (coffee capsules, printer ink) at a high price. However, this gamble doesn’t always pay off—savvy buyers may calculate the ongoing expenses of owning such products and choose not to take the bait. The result is that businesses may end up making an overall loss from this model. Many businesses have found the reverse of this model to be even more successful: They offer the premium product at a high price and the complementary product at a low price.
Businesses with Open business models create opportunities for innovation and efficiency by collaborating or co-creating with external partners. For example, NASA collaborated with TopCoder, Harvard Business School, and London Business School, to build an algorithm to assist manned missions. Osterwalder and Pigneur claim that there are two ways to create value through collaboration—businesses can either receive and integrate external resources to strengthen their own business models, or they can leverage their internal resources by supplying them for a fee.
For example, a business might supply external partners with intellectual property and profit from selling off any other resources that aren’t required internally. A business might receive resources from external partners, such as patents or research results, that contribute to the creation of innovative products and services.
(Shortform note: In addition to identifying physical and intellectual resources, businesses can also create value by leveraging their brand equity. For example, Xiaomi grew to become the world’s leading consumer internet-of-things company by forming alliances with partner firms. Xiaomi offered these partner firms significant value in the form of physical and intellectual resources such as research, development, and manufacturing resources, as well as brand capital—the firms benefited from access to Xiaomi’s millions of existing loyal customers without having to go through the long process of building a customer base and developing trust.)
Although nonprofit and social causes organizations do not seek to make profits in the conventional sense, they still need to have a business model to plan how they will meet their objectives and cover their expenses. Osterwalder and Pigneur distinguish between two different business model patterns defined by how these organizations receive revenue: donor-supported organizations and organizations that balance profit with social and environmental impact.
When third-party donors fund the organization’s mission, the business model has to place emphasis not only on how to fulfill the mission but how to appeal to third-party donors so that they support the mission. Therefore, the organization has to manage third-party donors in the same way that conventional profitable businesses manage their customers. Consequently, the development and management of these relationships form a large part of the organization’s activities.
(Shortform note: Aligning both donors and beneficiaries into one business model is difficult to balance. Donor-Supported Organizations need to focus on fulfilling their mission, but they also need to fully consider how they create value for their donors. In other words, donors are more likely to contribute if organizations can provide proof of specific and measurable improvements made possible by their donations.)
When the organization has to generate its own revenue to fulfill its mission, Osterwalder and Pigneur suggest that it should balance its need to make profits with its need to make a positive social and environmental impact. To evaluate this impact, the authors recommend extending the business model to include two additional elements: social and environmental costs of this business model, and social and environmental benefits of this business model.
(Shortform note: Many experts believe that all businesses should be held accountable for their environmental, social, and governance (ESG) impact, not just businesses that focus on social causes. However, companies haven’t quite figured out how to measure their ESG impact.)
Osterwalder and Pigneur provide a number of techniques you can use to generate innovative ideas to adapt or create your own business models. Further, there are a number of strategies you can incorporate to help you regularly analyze and optimize the effectiveness of your business models.
1. Generate innovative ideas: Osterwalder and Pigneur argue that you first need to generate and evaluate a large number of ideas before you can come up with viable options to create an innovative business model. The authors suggest you use one of the following objectives to trigger innovative ideas: serve unmet market needs, create new products or services, disrupt an existing market, or create a new market.
(Shortform note: The authors don’t mention that there are other significant opportunities to spark innovation. For example, shifts in the economic environment (growth or turmoil) can create new customer preferences and spending habits that trigger business innovation.)
2. Empathize with your customers: Osterwalder and Pigneur argue that if you find out what your customers want and figure out ways to help them before you design your products and services, you’re more likely to discover new opportunities and create a strong foundation for your business model.
(Shortform note: Specifically look for problems and inconveniences that your customers face both throughout their experience with your business and their experience with your products and services.)
3. Create visual representations: Osterwalder and Pigneur argue that visual representations of your business model allow you to better understand how each of your elements connects and interrelates.
(Shortform note: The Back of the Napkin argues that drawings can solve any problem, even if we’re convinced that we have no aptitude for it.)
4. Build detailed scenarios: Osterwalder and Pigneur suggest that you regularly create scenarios around possible future environments and the impact they will have on the way you operate. The authors recommend that you base your scenarios on the following four areas of your business environment: market, industry, key trends, and macroeconomics.
(Shortform note: Many experts argue that businesses need to consider how to evaluate and manage unanticipated external risks in advance, and develop appropriate risk management strategies to lessen their impact. For the purposes of this technique, you’ll find it beneficial if you focus on early indicators of change in your environment before you build your future scenarios.)
5. Create a story to communicate your business model: Osterwalder and Pigneur claim that creating a story centered around the value that your business model offers, from the perspective of either an employee or customer, will enable you to engage your listeners and effectively communicate your business model.
(Shortform note: You’re more likely to engage and resonate with your listeners if you recognize that each audience you address has different priorities. For example, your team cares about how your business model will affect their jobs, whereas your investors care about how they’ll profit from your business model.)
6. Prototype multiple versions of your business model: Osterwalder and Pigneur argue that prototypes of your business model will allow you to better understand the structure and combined effects of your elements. With this understanding, you can create multiple prototypes to explore and test various possibilities and strategic directions.
(Shortform note: The sooner you test your business model, the sooner you’ll know if your business model is worth investing in. There are a number of tools that you can use to test the viability of your business model. For example, you can use targeted advertising to measure consumer interest, or use your email database to test your value offer on existing customers.)
7. Use a SWOT analysis to evaluate your business model: Osterwalder and Pigneur suggest that you regularly use the Strengths, Weaknesses, Opportunities, and Threats (SWOT) analysis to evaluate the effectiveness of each of your individual elements, as well as your overall business model.
(Shortform note: There are various alternatives to the SWOT analysis that the authors don’t mention. For example, NOISE would be useful when you’re actively looking for solutions to solve problems within your organization, whereas Porter’s Five Forces Model offers an effective way to analyze your competition.)
8. Use Blue Ocean Framework to evaluate your business model: Osterwalder and Pigneur argue that using the “Four Actions Framework” to analyze the impact of each of your elements will put you in a position to create demand for innovative products and services in unclaimed markets.
(Shortform note: Porter’s Five Forces argues that businesses need to continually assess their competition to remain relevant in the marketplace. Management experts suggest that a blend of both strategies can be effective—use the “Four Actions Framework” to create your new market and then use Porter’s Five Forces to defend against your eventual competitors.)
9. Align your organization and resources: In addition to assessing your technology and resource requirements, the authors suggest that you use Jay Galbraith’s Star Model to assess whether you need to restructure or adapt your business operations to successfully implement your business model:
(Shortform note: One criticism of this approach is that it doesn’t offer any flexibility for you to adapt your business model. An alternative approach is to use your company values as a starting point—aligning your business model with your company’s values (instead of vice versa) will allow you the flexibility to innovate without having to evaluate your organizational structure.)
Business Model Generation, by innovation experts Alexander Osterwalder and Yves Pigneur, is a contemporary guide to systematic business innovation. Co-created by 470 practitioners from across 45 countries, the book provides a template for brainstorming and visualizing the overarching elements that make up a successful, holistic business model.
With this template, the authors analyze the different ways you can combine these elements to create successful business model patterns. In addition, they provide techniques you can use to generate your own innovative business models, as well as strategies you can incorporate to regularly analyze and optimize your existing business models.
Dr. Alexander Osterwalder is an entrepreneur and highly respected strategy and innovations expert. Osterwalder has co-authored a number of books on the subject of business strategy and innovation:
Connect with Alexander Osterwalder:
Dr. Yves Pigneur is a professor at the University of Lausanne. He has co-authored several books with Alexander Osterwalder, and he is renowned for his expertise in business strategy and innovation.
Connect with Yves Pigneur:
Dr. Alexander Osterwalder and Dr. Yves Pigneur originally worked together on a Ph.D. dissertation on the topic of business model innovation. After Osterwalder documented their approach in his business blog, businesses around the world, including Ericsson and Deloitte, began applying their method.
Osterwalder and Pigneur recognized that there was a demand for their book. However, they also recognized that the market was already saturated with strategy and management books with which they would need to compete. Therefore, they decided to implement their own business model process to come up with a way to finance, produce, and competitively position the book.
Instead of seeking a traditional publisher, they launched a subscription-based online platform to share their research. This platform not only financed the production of the book but facilitated co-creation with 470 global practitioners to create the book.
The authors did not have the support of a publishing house nor a marketing budget. Despite this, Business Model Generation quickly gained traction, is now required reading on many management courses, and has since sold over a million copies in 40 languages.
The book was eventually published by Wiley in 2010. Osterwalder and Pigneur have since co-authored a number of books together including:
Osterwalder and Pigneur have continued to develop their successful collaborations. Strategyzer, the consultancy firm they co-founded in 2010, provides online courses, applications, and services to help organizations build “invincible companies." Millions of business practitioners and leading global companies including Microsoft, Coca-Cola, Nestlé, MasterCard, Sony, and Fujitsu, rely upon the practical tools that they’ve developed.
Strategyzer provides a downloadable template for the Business Model Canvas, as well as other useful tools to accompany the book.
Many reviewers comment that the book is practical and engaging. They find the process of evaluating or designing a business model based on the Canvas easy to follow, and they find the tools and strategies covered in the book very useful.
However, some reviewers have commented that the book suffers from “style over substance” because it lacks the necessary depth to execute a business plan. These reviewers suggest that the book is more suited to beginners rather than professionals. Other reviewers have commented that the layout of the book is too disjointed, and they feel that the authors’ attempt to cover too many different methodologies diminishes the overall effectiveness of the book. Finally, some reviewers have commented that the book is overly repetitive with many of the tools, processes, and case studies overlapping.
The book provides a template for brainstorming and visualizing the overarching elements that make up a successful, holistic business model. It then demonstrates how to use this template to analyze or adapt existing business models, or design new models. In addition, it weaves in case studies and strategies to illustrate practical ways that businesses can use the template to successfully position their own business models.
There are six chapters: Canvas, Patterns, Design, Strategy, Process, and Outlook. The first two chapters explain what makes a successful business model and then describes different business models and how businesses can apply them. The authors provide supporting arguments from academics and strategists, as well as illustrations of existing business models to demonstrate each point.
However, from the third chapter onwards, the presentation of the concepts becomes less focused. The authors attempt to present a multitude of existing techniques and processes to use in conjunction with their business model template. However, these techniques originate from multiple sources and many of the tools and processes overlap. As a result, the last four chapters of the book suffer heavily from repetition.
This guide presents the authors’ key ideas behind what elements create a successful business model, their formulas behind successful business model patterns, and the strategies you can use to implement these ideas in your own business. In addition, we supplement each concept with up-to-date examples and commentary, and we suggest complementary processes to effectively incorporate their concepts into your own business models.
Business Model Generation, by innovation experts Alexander Osterwalder and Yves Pigneur, is a contemporary guide to systematic business innovation. Using their business model template, the authors analyze the different ways you can combine these elements to create successful business model patterns. In addition, they provide techniques you can use to generate your own innovative business models, as well as strategies you can incorporate to regularly analyze and optimize your existing business models.
(Shortform note: Many experts agree that the average lifespan of successful business models has fallen to less than five years. Therefore, to achieve a sustainable competitive advantage, businesses need to continually evaluate and redesign their business models.)
In this chapter, we’ll first briefly define what the Business Model Template is. Next, we’ll explore each of the nine overarching elements that you need to consider to create a successful business model.
Osterwalder and Pigneur developed a flexible template that they refer to as the “Business Model Canvas” to help you understand and focus on the nine overarching elements that they believe make up any successful business model. The template offers a visual framework to describe, assess, update, or design business models. You can use it to analyze the strategies of your competitors, to evaluate or to create new strategies for your existing business, or to design an entirely new business.
(Shortform note: The Lean Canvas is a popular adaptation of the Business Model Canvas. Developed by Ash Maurya, the author of Running Lean, it’s designed specifically for action-orientated start-up companies that rely on continuous experimentation to develop their products and services. Consequently, it places more emphasis on defining customer problems and identifying competitive solutions.)
Osterwalder and Pigneur encourage you to consider each of the nine elements as interdependent components that impact the effectiveness of the other elements. In other words, changes to one element can impose constraints or amplify the effects of other elements. Therefore, as you work on your business models, consider how you can leverage all of your elements to work together.
We’ve categorized the nine elements into the following groups:
Part 1: Your Customers and Your Value Offer
Part 2: Your Infrastructure
Part 3: Your Finances
(Shortform note: There are many alternatives to this template—each template emphasizes different areas and priorities for the development of specific business models.)
Define the different groups of customers your business intends to target—Osterwalder and Pigneur refer to this element as “Customer Segments.” You may serve one group of customers or several groups of customers depending on the needs you intend to fulfill. The authors state that your customers represent different groups if you need to:
Once you’ve categorized your customers into distinct groups based on their needs or the way they interact with you, you can target these groups by designing your business model around their specific customer needs.
(Shortform note: The Four Steps to the Epiphany, by Steve Blank, emphasizes the importance of identifying and validating your customer groups before you develop your business model. The book includes a four-step customer development process to help businesses effectively define and target customer groups: 1) discover customers for your product or service, 2) validate your product and touchpoints, 3) create demand for your product or service, and 4) build strategies focused on customer management.)
Osterwalder and Pigneur argue that you need to approach each of your customer groups in specific ways when planning your business model. They provide the following examples of different types of customer groups:
Mass Market
For Mass Markets, the focus is on one large customer base with similar needs. Therefore, it isn’t necessary to distinguish between different customer groups when planning each of the other elements in your business model. For example, Colgate doesn’t need to differentiate its customers since toothpaste is an essential, widely-used personal care product. Therefore, Colgate can align all of its business model elements towards appealing to and engaging as many people as possible.
(Shortform note: Two popular techniques used by mass marketers include the shotgun approach, which attempts to reach a large audience through the use of mass media (television, radio, and so on), and guerilla marketing, which relies upon unconventional tactics to surprise an audience.)
Niche Market
For Niche Markets, business models need to cater to specific customer groups and tailor each of the other elements to effectively target these specialized needs. For example, Lush targets customers who care about vegetarian products (no animal testing) and eco-friendly practices. Therefore, they align all of their business model elements to ensure the business focuses on environmentally friendly methods.
(Shortform note: Products once catered towards niche markets are becoming more mainstream. This is particularly relevant in the healthcare industry due to increased levels of awareness regarding personal wellbeing and environmental sustainability.)
Subdivided Market
For Subdivided Markets, business models offer slightly different products and services to accommodate the needs of each of their customers. The way that they position each different product and service defines how they approach each of the elements. For example, an estate agent’s customers all want to buy or rent property. The estate agent can segment these customers into groups based on their income and on whether they wish to buy or rent. The higher the customer is willing to pay, the more emphasis the estate agent may have to put on developing customer relationships. This in turn affects the overall costs involved in targeting individual customer groups.
(Shortform note: There are four ways to approach segmentation: demographic, geographic, psychographic, and behavioral. Each way offers its own unique purpose—you’ll need to consider which way(s) will help you to meet your specific goals. For example, there may be little value in segmenting customers according to their geographic location if you sell and distribute your products and services solely through online channels.)
Diversified Market
Businesses that cater to two or more unrelated customer groups with different needs, have to base their business models around distinct products and services. All of the elements need to accommodate these distinct products and services. For example, Johnson & Johnson provides healthcare products and services to consumers. However, they also provide medical devices and equipment for hospitals. Johnson & Johnson has to target both of these customer groups separately to effectively cater to them.
(Shortform note: Diversification may seem like a promising way to increase the value you offer and create revenue. However, many companies have tried and failed to diversify. For example, did you know that Coca-Cola began a wine business in 1977? To increase your chances of success, experts agree that it’s important to have a strategy in place to manage how you approach your diversification decision-making process.)
Multi-Sided Market
Businesses that serve interdependent customer groups need to create products and services of equal value for each customer group. For the business model to function, each element needs to accommodate the full range of products and services on offer to both parties. For example, online marketplaces need to accommodate both buyers and sellers to operate efficiently—they can’t serve one group without the other group’s active participation.
(Shortform note: A multi-sided market increases in value the more people use it. The term for this is “network effect.” Network effects can be both direct and indirect. Direct network effects are when the value of the service goes up in proportion to how many users it has. For example, for a marketplace, more suppliers create more buyers, which leads to more suppliers, and so on. Indirect network effects come from the addition of new user groups. For example, for a marketplace, the addition of Paypal to facilitate transactions adds more value for both buyers and sellers.)
Define your touchpoints, how you’ll communicate with your customers and deliver your products and services—Osterwalder and Pigneur refer to touchpoints as “Channels.” For your communication, sales, and distribution touchpoints, you have the option of using your own touchpoints (assets under your direct control such as your website or your store), or partner-owned touchpoints (external touchpoints that result from cooperation with marketing agencies or distribution partners), or a mix of both. In addition, the authors also make a distinction between direct touchpoints (communication you control such as your blog), and indirect touchpoints (communication you can’t control such as user reviews).
The authors state that there are five distinct stages to consider when defining your touchpoints:
Touchpoints and Interactions (Element 3) are closely linked—consider the level of interaction you want to have with your customers when defining your touchpoints.
Businesses tend to assume that more touchpoints will lead to more customers, so they work hard to create multiple interaction points across the five stages. However, research indicates that too many touchpoints can reduce the quality of service that you deliver and damage customer experience. Customers care more about the quality of service you provide than what touchpoints you use—you’re more likely to create successful channels if you prioritize the development and integration of fewer interaction points.
Define the type of interactions you want to establish for each of your customer groups—Osterwalder and Pigneur refer to this element as “Customer Relationships.” The authors advise that you consider what your motivations are for communicating with your customers as your approach will differ depending on whether you intend to acquire new customers, retain existing customers, or upsell to existing customers.
It’s important to note that the interactions customers have with your business deeply influence how they experience your products and services, so you need to carefully consider how you can meet their needs and create the right balance. The authors provide a list of ways to interact with your customers:
Customers expect businesses to understand the relationships they want and to respond appropriately. However, despite spending billions trying to understand customer relationships, businesses often don’t understand these expectations and end up undermining their interaction efforts.
Brand relationship experts have identified 29 different types of interactions that customers expect from a business—they use relationship metaphors such as “one-night stand” or “marriage” to clearly define each interaction. These experts argue that businesses can’t understand or leverage customer relationships unless they collect and analyze the relationship signals their customers send.
Define how you intend to offer value to these customers—Osterwalder and Pigneur refer to this element as “Value Propositions.” Your value offer outlines the benefits you intend to provide in the form of products and services. The authors state that successful value offers align with the needs of your customers and differentiate themselves from existing solutions.
When creating your value offer, consider these questions:
(Shortform note: Osterwalder and Pigneur’s Value Proposition Design delves further into the topic of creating, testing, and improving your value offer.)
Businesses often associate value creation with competition—they assume that they need to offer something that outperforms and displaces what’s currently on the market. However, Sesame Street, life coaching, and Viagra all prove that it’s possible to create innovative products and services without disrupting existing markets. Instead, the businesses behind these products and services bypass competition by focusing on creating demand in entirely new marketplaces.
Define what resources you need to create and deliver your products and services to your customer—Osterwalder and Pigneur refer to this element as “Key Resources.” According to the authors, you can own, lease, or acquire the resources you need. All resources fall into the following categories:
Osterwalder and Pigneur suggest that you identify what resources you need to deliver your products and services—this method often highlights the need to acquire more resources before you can move forward with your business model. However, some businesses approach this in reverse: They use their resource limitations to inspire product and service innovations.
For example, Southwest Airlines once had to sell one of their planes to avoid filing for bankruptcy. Instead of seeking additional resources, they confronted this new constraint (limited funds and limited planes) and sought a way to maintain their existing routes with fewer resources. Their shift in focus from “How can we get more resources?” to “How can we optimize our current resources?” led them to make changes that drastically improved their flight boarding processes.
Southwest Airlines used its resource constraints to reposition its offering, differentiate itself from competitors, and become one of the most profitable airlines in the industry. This example emphasizes that you can create as much value from focusing on your resource limitations, as you can from acquiring new resources.
Define the alliances you need to form to optimize your business model and increase market share, acquire resources, or reduce risk—Osterwalder and Pigneur refer to this element as “Key Partnerships.” In other words, what alliances will provide you with a sustainable competitive advantage and help you to grow quickly? The authors distinguish between four different types of alliances:
Define the core actions you need to take to operate successfully and meet customer demands—Osterwalder and Pigneur refer to this element as “Key Activities.” The authors state that your actions will fall into the following categories:
(Shortform note: Osterwalder and Pigneur don’t provide practical advice here since different business models rely on different activities to operate successfully. Measure What Matters provides an effective goal-setting process that you can use to define the objectives (your end goal) and key results (how you will achieve your end goal) for each of your business model elements. For example, if you intend to manage platform interactions between different customer groups, your objective could be to acquire X number of customers in each group. Your key results could be: grow platform visitors by 5% every month, increase organic traffic by 10% every six weeks, and so on.)
Define how you intend to profit from the value you provide to your customers—Osterwalder and Pigneur refer to this element as “Revenue Streams.” The authors state that there are two types of income streams to consider, profits from single transactions, and profits from ongoing payments such as subscriptions. You may have multiple income streams for each of your customer groups. Further, each of these income streams may involve different pricing mechanisms depending on whether you choose to set a fixed or variable price for your products and services.
The authors include the following ways to generate profits:
How should you determine the price for your products and services? Many businesses determine their prices using the cost-plus method—calculate the costs involved and add on a percentage (desired profit). However, experts argue that businesses need to consider how much value customers attach to their products and services before they determine their prices.
Further, businesses need to recognize that their customers perceive the value of their products and services in different ways depending on their specific requirements. If businesses build these variations into their pricing structure, they can expect to receive higher profits than they would with a single pricing policy.
Define the expenses of operating all of the elements you’ve defined in your business model—Osterwalder and Pigneur refer to this element as “Cost Structure.” Your expenses will vary depending on whether you choose to minimize costs and offer an inexpensive product or service, or if you choose to create premium-priced products and services. The authors state that your costs structures will include at least one of the following characteristics:
All of your costs will also fall into the following categories:
Direct costs: specific expenses related to your business model elements such as paying to manufacture your product
Indirect costs: general costs that keep your business operating such as paying rent, utilities, and salaries
Knowing the difference between these costs will help you to identify your overall business expenses.
Create an overview of your business model by focusing on the what, who, and how of your value offer.
Think of one product or service you intend to offer. What value does it offer? What problem does it solve?
Who are you offering this to? Who needs your solution?
How is your offer more valuable than what your competitors are offering? Why would your customers choose your value offer?
How do you intend to make money with your value offer?
Osterwalder and Pigneur argue that you can combine the nine elements into distinct patterns to create specific outcomes for your business. To illustrate this, they present patterns they claim are common across all successful business models—a single business model can include several of them. Once you familiarize yourself with these patterns, you’ll understand how the combination of certain elements can create dramatically different results, and you’ll be better prepared to manipulate the elements to successfully position your business.
(Shortform note: The Business Model Navigator presents an alternative way to approach business model patterns—it offers 55 patterns that you can pick and choose from, manipulate and combine to suit your needs. This method may be more suitable for established businesses looking to innovate existing business models.)
In this chapter, we’ll look at the first three formulas: Unbundled, Long Tail, and Multi-Sided Platforms. In the next chapter, we’ll explore the remaining two formulas, Free and Open, as well as specific formulas for nonprofit and beyond-profit organizations.
Unbundled businesses split up their operations into three distinct business categories to increase efficiency—this is because each business category is driven by different factors and defined by its own set of rules and operating procedures:
Businesses Focused on Product Innovation:
Businesses Focused on Customer Relationship Management:
Businesses Focused on Infrastructure Management:
Since each category plays a unique role and relies upon different teams and departments to operate, management experts John Hagel and Marc Singer argue that businesses that offer services in one or more of these distinct categories can’t operate efficiently unless they split (“unbundle”) these services into discrete business identities.
Further, they advise that businesses should focus only on one of these categories as their core service, and outsource the rest to specialized companies. As long as more than one of these activities coexist on a single business model, each of the elements will include conflicting priorities that will create limitations or “tradeoffs” across the business.
Outsourcing Reduces Operating Costs
The concept of “unbundling” directly counters traditional business philosophy, particularly regarding operating costs. Operating costs are defined by how much time, money, and effort it takes to exchange ideas, services, or assets required to operate a business. Traditionally, businesses operate on the assumption that it’s more efficient and cost-effective to manage all company processes internally, so they invest in creating various departments within their organization to manage all of their activities.
For example, you create your own marketing department, invest in hiring and training employees trained in marketing, and develop processes and systems so that this department can align with your needs as a business. You do this because you assume having your own marketing department will reduce your costs in the long term—if you outsource your marketing needs, you may have to spend additional time (send a brief or style guide, provide access to necessary materials, and resolve queries) and money to get every job done.
Business experts Hagel and Singer argue that this assumption is outdated since network developments allow specialized companies to work in sync with businesses. Further, they claim that businesses that attempt to manage all processes internally incur additional operating costs.
This is because specialized companies focus on optimizing one single activity. This single-minded focus grants them enormous advantages over businesses that need to share their resources to manage a range of activities. Specialized companies can direct all of their resources to:
Hire highly qualified and specialized employees
Gain deep industry knowledge in their specific area
Invest in the latest technologies
Develop processes so that they can easily work with other businesses
Businesses that leverage the capabilities of specialized companies gain resources without having to invest in the development, ongoing management, and integration of different departments and processes. Consequently, these businesses can focus their resources on their core activity, increase productivity, and decrease unnecessary overhead costs.
To avoid the conflicting priorities that limit “bundled” businesses, Osterwalder and Pigneur suggest you leverage your elements to “unbundle” as follows:
| Customer Relationship Management | Product Innovation | Infrastructure Management | |
| Customer Groups | Focus on targeting specific customer groups. | Outsource customer group research and development to external partners. | Outsource to external partners—focus mainly on serving other businesses. |
| Value Offer | Value comes from offering a high quality of customer service. | Value comes from offering high-quality product and service innovations. | Value comes from providing high-quality infrastructure services. |
| Touchpoints | Create multiple touchpoints to facilitate customer interactions. | Outsource the management of touchpoints to external partners. | Outsource the management of touchpoints to external partners. |
| Interactions | Focus on acquiring customers and building strong relationships to ensure customer loyalty. | Outsource the management of customer interactions to external partners. | Outsource the management of customer interactions to external partners. |
| Profit Sources | Profit to come from long-term customer transactions—focus on their lifetime value. | Rely on high-profit margins—innovative products and services sell for higher prices. | Rely on low-profit margins—charge low prices but make profit from the high volume of sales. |
| Resources | The customer base built from developing touchpoints and interactions will eventually become a resource. | Talented and creative employees, as well as research and development facilities. | The more the infrastructure expands, the more of a resource it will become. |
| Critical Actions | Acquire customers and build trust to inspire customer loyalty. | Manage research and development facilities, and attract talented employees. | Develop and maintain the infrastructure. |
| Network | Outsource infrastructure management and product and service innovation requirements to external partners. | Outsource as much as possible so the business can focus on product and service innovation. | Outsource as much as possible so the business can focus on infrastructure management. Develop partnerships to help develop and manage the infrastructure efficiently. |
| Expenses | Invest heavily in marketing, developing touchpoints and interactions, to acquire customers. | Invest heavily in talented employees to manage the research and development processes. | High fixed costs will decrease as operations increase thanks to economies of scale. |
Osterwalder and Pigneur refer to the recommendation from management experts that companies should narrow their business focus on delivering superior value in line with one of three value disciplines: product leadership, customer intimacy, or operational excellence. These value disciplines complement the three business categories and support the argument to “unbundle” the services.
Interestingly, companies that focus on the same value disciplines display similarities in the way that they operate, regardless of their industry. For example, the operating structures and workplace cultures of Federal Express and Walmart are almost identical because they both pursue operational excellence.
The Benefits of Unbundling
In order to function efficiently, Amazon has split into multiple divisions to better serve the varying needs of the massive number of consumers and businesses it caters to.
Amazon Marketplace
Amazon Prime
Amazon Web Services
Amazon Kindle
Amazon Patents
Amazon Advertising
Each of these divisions has its own operating procedures, defined by its “value disciplines” to avoid unnecessary trade-offs or conflicts within the business as a whole. For example, Amazon Web Services provides infrastructure management and caters specifically to other businesses. Amazon needs to manage the way that it develops this service, and then acquires and interacts with these business customers in a very specific way. Since this is an entirely separate division, it has the necessary freedom to provide an efficient service and adapt to customer needs without being slowed down by the different priorities of other divisions.
Long Tail businesses focus on creating a wide variety of diverse niche products and services for interested buyers—individually, each of these products sells very little, but the combined sales of all of the products generate high revenues. These models require cost-effective ways to manage large inventories, reach potential buyers, and facilitate transactions. Further, Long Tail businesses often encourage the co-creation of products by allowing individual users to produce and distribute their own creations—they need a powerful platform to facilitate this form of customer-business collaboration.
Osterwalder and Pigneur suggest the following layout for Long Tail business models:
| Customer Groups | Focus on multiple niche customer groups as well as multiple niche suppliers—both groups are interdependent. |
| Value Offer | Value comes from offering a wide range of niche products alongside a few mainstream products. Additional value comes from providing content production tools for users to co-create products. |
| Touchpoints | Online methods are usually the most cost-effective. |
| Interactions | Online methods are usually the most cost-effective. The level of interaction required depends on the nature of the products and services on offer. |
| Profit Sources | Profit sources will come from combined sales across the platform, as well as paid advertisements. |
| Resources | The larger the platform, the more of a resource it will become. |
| Critical Actions | Develop, manage, and promote the platform to acquire niche content suppliers and customers. |
| Network | Focus on developing partnerships with both professional and amateur niche content providers. In addition, focus on partnerships that will make the platform more functional or attractive to both suppliers and customers. |
| Expenses | Platform management and development will incur the highest costs. |
Book Publishing: From Mainstream to Long Tail
The Long Tail formula seems to fly in the face of the common advice to focus on a single niche product or service (in other words, to prioritize one thing and do that thing exceptionally well). Further, expanding your offerings according to the Long Tail formula could be the key to disrupting the market and winning big. Changes in the publishing industry are a great example of this.
Traditionally, publishers had to print and distribute books to bookstores before they could sell them. This incurred heavy printing, inventory, and distribution costs. Publishing houses were responsible for managing the editorial, marketing, production, and distribution costs for each title they published. They had to carefully plan their publishing schedules for both their frontlist (books to be published) and backlist (books previously published) titles to make a profit.
To evaluate frontlist titles, they weighed the projected sales (what they expected customers to buy) against the editorial, production, and royalty costs the book would incur. They only approved books that seemed likely to make a profit.
To evaluate whether backlist titles should stay in print, publishers analyzed the book’s existing sales record to determine whether the book’s demand was worth the cost of printing further copies. If the publishers decided that the book was not worth printing, customers would have no awareness of this book or, if they did, they would find it difficult to find a copy.
In addition, brick and mortar bookstores had limited shelf space to stock books—they had to justify the inclusion of each and every title on their shelves. Therefore, the majority of bookstores stocked only the bestselling titles.
The fact is that publishers and bookstores didn’t really know what people wanted—limited resources pushed them to make assumptions about what people wanted and to fabricate demand through the use of mass marketing. In other words, customers bought these books because they didn’t have any other options.
Amazon’s Long-Tail Model
Amazon’s long tail model disrupted this model in two ways. First, it made more books available to customers through Amazon Marketplace. Second, it allowed authors to self-publish their own books through Amazon KDP.
Amazon Marketplace is not restricted by shelf space or inventory costs—print-on-demand facilities allow them to store books as electronic files instead of hard copies. Amazon creates demand for books that brick and mortar bookstores don’t have the resources to carry—it makes customers aware of a wide variety of books (based on buying patterns and preferences), creates demand by displaying customer reviews, and facilitates the purchase of these books. It’s interesting to note that more than half of Amazon’s book sales come from books that are not sold in traditional bookstores—Amazon created a new market based on books customers actually want.
Amazon KDP authors have the option of doing all of the editorial and design work for their books, or they can pay for additional services to manage and promote their books. This means that Amazon KDP doesn't have to cover the editorial or marketing costs for publishing these books.
Since there are no inventory costs or author advances to pay, Amazon KDP doesn’t lose out financially if a book doesn’t sell. When a customer purchases a book, Amazon KDP prints the book and deducts this printing cost from the sale price of the book. So they only pay the printers and authors as and when a book sells, and all parties profit from the first sale. Millions of authors use Amazon KDP to self-publish books, and while they don’t sell every one of these books, the aggregate sales of all of the books allow Amazon KDP to thrive.
Multi-Sided Platforms enable direct interaction between two or more different but interdependent groups of customers. This pattern is most obvious in a marketplace such as Etsy—this business facilitates exchanges between buyers and sellers, and it requires participation from both parties to offer value and operate successfully. In other words, if sellers stopped listing items on Etsy, customers would see no value in visiting the site. If customers stopped shopping on Etsy, sellers would see no value in listing their products. The more active users that a platform can attract, the more value it can offer to both parties.
Osterwalder and Pigneur suggest the following layout for Multi-Sided Platform business models:
| Customer Groups | Focus on a minimum of two interdependent customer groups. |
| Value Offer | Value comes from the platform—it facilitates efficient and cost-effective interactions between the customer groups. |
| Touchpoints | Online methods are usually the most cost-effective. |
| Interactions | Online methods are usually the most cost-effective. The aim here is to facilitate interactions between the customer groups. |
| Profit Sources | Each group produces a different revenue stream depending on the fees they pay to use the platform (for marketplaces, sellers usually pay subscription fees while buyers have free access). |
| Resources | The more customers the platform can provide benefit to, the more of a resource it will become. |
| Critical Actions | Develop, maintain, and promote the platform to ensure it meets the needs of individual customer groups. |
| Network | Focus on developing partnerships that will make the platform more functional or attractive to all customer groups. |
| Expenses | Platform management and development will incur the highest costs. |
The Negative Impact of Network Effects on Sellers
Marketplaces are generally free for buyers to use—buyers only pay for the products and services they buy, not for using the platform. However, sellers are expected to pay various transactional fees for the benefits they receive from using these platforms, regardless of whether or not they make a sale. The platform promises to deliver them more attention, more visibility, and more opportunities to sell their products, and sellers are willing to pay for instant access to the platform’s global customer base.
As discussed, a multi-sided platform increases in value the more people use it. However, the more saturated these marketplaces become, the more difficult it is for sellers to stand out and attract the attention of buyers. In other words, the platform relies on having more sellers to function, but the more sellers it hosts, the more difficult it becomes for existing sellers to ensure the long-term viability of their business.
Over-saturation of the platform creates a high risk of sellers moving to other, more beneficial platforms. Sellers may no longer see the value in paying fees to be part of an over-saturated platform and end up switching to competing platforms that offer slightly different benefits (for example, different customer groups, varying fee structures, and transaction costs). Or they choose to use multiple platforms to expand their market reach and make more sales.
For example, consider Amazon Handmade and Etsy. Both platforms facilitate transactions between buyers looking for handmade products and sellers of handmade products, and they both offer slightly different fees and benefits. Handmade sellers can pick and choose between the two platforms (as well as multiple other handmade marketplaces) depending on the nature of their products and services, and the best return on their investment and time. Consequently, multi-sided platforms are forced to compete fiercely on both price and quality to keep their sellers from switching to competitor platforms.
In this chapter, we’ll look at the remaining business model formulas: Free, Open, and specific formulas for nonprofit and beyond-profit organizations.
The Free business model pattern ensures that at least one customer group always receives value for free. While different patterns make the model financially viable, Free users are always financed by another part of the business model or by another customer segment. Osterwalder and Pigneur categorize Free models into three groups, based on where their revenue comes from: advertising, premium services, and continuing purchases.
In this model, Multi-Sided Platforms encourage advertisers to subsidize free users. For example, the revenue that Google receives from advertisers enables Google users to make unlimited searches for free. The more free users, the more advertisers are willing to pay to access these users.
Osterwalder and Pigneur suggest the following priorities for Free business models subsidized by advertising revenues:
| Customer Groups | Focus on large customer groups to entice advertisers. |
| Value Offer | Value comes from providing a free product or service to customers. The resulting customer base will create value for advertisers. |
| Touchpoints | Depends on the type of product or service. |
| Interactions | Depends on the type of product or service. |
| Profit Sources | Profit comes from advertisers using the platform. |
| Resources | The larger the platform becomes, the more of a resource it will become. |
| Critical Actions | Develop and maintain the platform to entice both customers and advertisers. |
| Network | Focus on developing partnerships that will make the platform more functional or attractive to all customer groups. |
| Expenses | Platform management and development, as well as traffic generation, will incur the highest costs. |
Facebook’s Advertising Revenue
Facebook’s family of apps (Instagram, Messenger, Whatsapp) provides a free service to more than 3 billion users worldwide. Facebook clearly has two primary groups of customers: Users, who they provide value for in the form of free communication, and advertisers, who they rely upon for revenue.
Facebook collects and analyzes data to categorize each of its users: who they are, what they care about, who they communicate with, and what content they spend time on both within and outside of Facebook apps. The more time that users spend on Facebook apps, the more data Facebook collects to categorize these users.
Facebook auctions off advertising space within users' feeds and stories based on the categorizations they’ve created. Further, Facebook provides advertisers with performance tracking data on how effective different campaigns are, for example, how often users click on certain advertisements. These categorizations and performance analyses are accurate enough that advertisers are willing to pay for the opportunity to create targeted marketing campaigns. In fact, over 10 million advertisers use Facebook’s advertising platform.
Facebook’s 2020 revenue: On average, Facebook earned an average of $32 from each of its users, totaling $84.2 billion in advertising revenue—advertising represented 98% of Facebook’s $86 billion revenue for that year alone.
Facebook has faced many accusations regarding the way it manages the security and privacy of its users. However, Facebook doesn’t sell personal data to advertisers—just advertising space based on user demographics. Still, the increasing scrutiny of the government and public demonstrates that applications of this Free model may need to change in the future.
Premium Service models—Osterwalder and Pigneur refer to these as “Freemium models”—give customers the option to use the basic service for free or to pay for premium or additional services. The revenue from paying customers supports the costs incurred by the free users. The larger the customer base for paid services, the more revenue there is to support free users. For example, Evernote offers three plans to users: free, personal, and professional, and users can choose to upgrade and pay if the free service doesn’t meet their needs.
Osterwalder and Pigneur suggest the following layout for this type of business model:
| Customer Groups | Focus on creating a large group of free users. Eventually, convert a portion of this group into paying users. |
| Value Offer | Value comes from providing a free basic service to a large customer group, as well as offering a premium service to a smaller customer group. |
| Touchpoints | Online methods are usually the most cost-effective. |
| Interactions | Automate as much as possible to efficiently serve the large customer group. |
| Profit Sources | Profit will come from customers paying for premium services. Calculate the conversion rate from free users to premium users to determine profit. |
| Resources | The platform that offers the free service is the main resource. |
| Critical Actions | Develop, maintain, and promote the platform to ensure it meets the needs of both free and paying users. |
| Network | Focus on developing partnerships that will make the platform more functional or attractive to both free and paying users. |
| Expenses | Platform management and development will incur the highest costs. There will be fixed costs for providing services to the two different groups of users, free and paying. |
The Difference Between Freemium and Free Trial
Both customer acquisition methods offer free services to customers. However, the difference between the two is that Freemium models limit user functions whereas Free Trials limit user time. Freemium services offer a free basic service to users with an option to pay for premium functionality. Free Trials typically offer users premium functionality for a limited time, after which the user must make the decision to either start paying to use the service or to stop using the service.
Freemium models provide “free value forever” and this is more attractive to users than “free value for a limited time.” Consequently, businesses using Freemium models are more likely to grow their customer base at a much faster rate than businesses using Free Trials. However, the problem with Freemium models is that they create no sense of urgency for users to upgrade—converting free users to paying users can take months or years, if ever. Meanwhile, businesses have to pay to maintain and develop the services it offers to these users.
The more value a Freemium service offers to free users, the more likely it is to create procrastination—users will happily benefit from the free service as long as possible. But if businesses add restrictions to the free offer to create a sense of urgency, users are likely to feel betrayed. This was demonstrated when Evernote placed limitations on its free service and raised subscription fees.
Ultimately, businesses offering Free Trials are more likely to create profits in the short term as they don’t have the additional expense of serving a large base of free users for an unlimited time. However, if businesses using Freemium models can strike the right balance between offering enough free value to grow their customer base, and offering enough premium value to convert users into paying customers, they can create substantial profit in the long term.
Continuing Purchases models—Osterwalder and Pigneur refer to these as “Bait and Hook” models—are characterized by cheap or free products that provide customers with instant gratification but create demand for future products and services. Although businesses initially lose money, they can easily cover the costs and make a profit from the recurring income they receive from these transactions. For example, coffee machines that require specific capsules to function can sell at a loss since customers will inevitably pay for the capsules so that they can use the machine.
Osterwalder and Pigneur suggest the following layout for this type of business model:
| Customer Groups | Focus on large customer groups. |
| Value Offer | Value comes from attracting customers with an inexpensive or free offer, which will lead to a necessary follow-up product or service. |
| Touchpoints | Depends on the product or service. |
| Interactions | Interactions need to encourage customers to have no choice but to purchase follow-up products or services. |
| Profit Sources | Profit will come from multiple purchases of the follow-up product or service. |
| Resources | Product patents, as well as brand equity—brand reputation and familiarity—will be the biggest resources. |
| Critical Actions | Focus on the production and delivery of follow-up products & services. |
| Network | Focus on developing partnerships that will make the production and delivery of follow-up products and services more efficient. |
| Expenses | The main expenses will be the subsidization of the initial value offer, as well as the production of the follow-up products and services. |
Reversing the Model
Business models focused on continuing purchases generally offer the premium product (for example, coffee machine or printer) at a low cost and its complementary product (coffee capsules, printer ink) at a high price. In effect, businesses choose to initially make a loss in the hope of making a future profit from ongoing purchases. However, this gamble doesn’t always pay off—savvy buyers may calculate the ongoing expenses of owning such products and choose not to take the bait. The result is that businesses may end up making an overall loss from this model.
Many businesses have found the reverse of this model to be even more successful—they offer the premium product at a high price but keep the complementary product at a very low price. In other words, customers pay a high price upfront so that they can receive long-term benefits from low price add ons.
For example, Apple products require a high degree of investment from consumers. However, consumers are happy to pay the price to enjoy low-priced music and apps at affordable prices. Similarly, Amazon’s Kindle devices are also sold for high prices, but consumers benefit from accessing millions of free or low-priced ebooks. If both Apple and Amazon Kindle continue to provide access to low-price complementary products, consumers will be willing to pay high prices for their premium products.
Unlike the original model, businesses do not suffer a loss when customers fail to purchase complementary products. Further, even though the complementary products offer a low profit margin, they still provide businesses with ongoing and predictable revenue streams.
Businesses with Open business models create opportunities for innovation and efficiency by collaborating or co-creating with external partners. For example, NASA collaborated with TopCoder, Harvard Business School, and London Business School to build an algorithm to assist manned missions.
Osterwalder and Pigneur claim that there are two ways to create value through collaboration—businesses can either receive and integrate external resources to strengthen their own business models, or they can leverage their internal resources by supplying them for a fee.
| Receive Resources | Supply Resources | |
| Customer Groups | Focus on creating partnerships with organizations that require existing internal resources. | |
| Value Offer | Value comes from anything that won’t be used internally such as research results or intellectual property. | |
| Profit Sources | Profit comes from selling off any resources that aren’t required internally. | |
| Resources | Focus on evaluating external resources and develop methods to work with external networks—these capabilities will become the main resource. | |
| Critical Actions | Evaluate external resources, develop and manage the infrastructure to connect these external resources with existing internal processes. | |
| Network | Focus on developing partnerships with organizations that can provide value in the form of innovative products and services or research. | |
| Expenses | Acquiring external resources, as well as developing the infrastructure to work with these resources, will incur the highest expenses. |
(Shortform note: In addition to identifying physical and intellectual resources, businesses can also create value by leveraging their brand equity. For example, Xiaomi grew to become the world’s leading consumer internet-of-things company by forming alliances with partner firms. Xiaomi offered these partner firms significant value in the form of physical and intellectual resources such as research, development, and manufacturing resources, as well as brand capital—the firms benefited from access to Xiaomi’s millions of existing loyal customers without having to go through the long process of building a customer base and developing trust.)
Although nonprofit and social causes organizations do not seek to make profits in the conventional sense, they still need to have a business model to plan how they will meet their objectives and cover their expenses. Osterwalder and Pigneur distinguish between two different business model patterns defined by how these organizations receive revenue: Donor-supported organizations and organizations that balance profit with social and environmental impact.
When third-party donors fund the organization’s mission, the business model has to place emphasis not only on how to fulfill the mission but how to appeal to third-party donors so that they support the mission. Therefore, the organization has to manage third-party donors in the same way that conventional profitable businesses manage their customers. Consequently, the development and management of these relationships form a large part of the organization’s activities.
(Shortform note: Aligning both donors and beneficiaries into one business model is difficult to balance. Donor-Supported Organizations need to focus on fulfilling their mission, but they also need to fully consider how they create value for their donors. In other words, donors are more likely to contribute if organizations can provide proof of specific and measurable improvements made possible by their donations.)
When the organization has to generate its own revenue to fulfill its mission, Osterwalder and Pigneur suggest that it should balance its need to make profits with its need to make a positive social and environmental impact. To evaluate this impact, the authors recommend extending the business model to include two additional elements:
(Shortform note: Many experts believe that all businesses should be held accountable for their environmental, social, and governance (ESG) impact, not just businesses that focus on social causes. However, companies haven’t quite figured out how to measure their ESG impact.)
Now that you understand the most common business model formulas, we’ll look at techniques you can use to generate innovative ideas to adapt or create your own business models. We’ll also explore strategies you can incorporate to help you regularly analyze and optimize the effectiveness of your business models. The following nine techniques will help you develop, test, and evaluate your business model:
Part 1: Innovation Techniques
Part 2: Optimization Techniques
Osterwalder and Pigneur argue that you first need to generate and evaluate a large number of ideas before you can come up with viable options to create an innovative business model. They suggest that you assemble a diverse team of colleagues from across different departments and from different levels of your business to brainstorm and discuss possibilities. Further, consider including people from outside your business to help stimulate new ideas.
The authors suggest you use one of the following objectives to trigger innovative ideas:
(Shortform note: The authors don’t mention that there are other significant opportunities to spark innovation. For example, shifts in the economic environment (growth or turmoil) can create new customer preferences and spending habits that trigger business innovation.)
Each of the nine elements can serve as a starting point for generating ideas and can have a powerful impact on how you arrange the rest of the elements within your business model. In addition, asking “what if” questions will help you to explore potential possibilities and provoke new ideas. To begin your brainstorming session, Osterwalder and Pigneur suggest that you consider how you can:
Established companies can find it difficult to define, challenge, and redesign their existing business models. The more successful these businesses become, the more difficult they find it to anticipate risks and proactively implement innovative strategies. In fact, pushing for innovation can seem risky during times of success.
However, management experts argue that businesses need to establish a framework that allows them to analyze opportunities, align their operations with what they intend to offer, and ensure that they remain adaptable to ongoing changes in the market.
The first step is for businesses to explicitly understand the strengths and limitations of their existing business models. Once they understand how the elements within their current business models interact, they’ll have a better understanding of the resources they can leverage to generate more ideas and create more opportunities.
Osterwalder and Pigneur argue that if you find out what your customers want and figure out ways to help them before you design your products and services, you’re more likely to discover new opportunities and create a strong foundation for your business model. To find unsatisfied, or hidden needs that your customers may not even be conscious of, the authors suggest that you pair basic customer profiling (demographics) with a deeper analysis and exploration of your customers’ experiences and underlying motivations.
Another way to approach this is to specifically look for problems and inconveniences that your customers face both throughout their experience with your business and their experience with your products and services. This is an effective way to create more value for your customers either in what you offer or how you interact with them. For example, one business noticed that consumers are reluctant to buy electric fryers because deep-fried food is unhealthy and the machines are difficult to clean—they transformed the problem into a solution by creating Actifry, a machine that creates tasty fries with only one tablespoon of oil. Actifry converted a problem into revenue totaling €1 billion by addressing customer concerns.
Osterwalder and Pigneur argue that visual representations of your business model allow you to better understand how each of your elements connects and interrelates. They designed the business model template to encourage collaboration across teams and departments—it’s intended to be reproduced in a large format to allow groups of people, armed with Post-it™ notes and markers, to strategically discuss each element. The authors claim that Post-it™ notes and drawings can express ideas more succinctly than abstract concepts expressed in text. In other words, the visual representations give you something tangible to focus your discussions on and allow you to better communicate your ideas. (Osterwalder and Pigneur also developed a Toolbox to support the creation of online collaborative methods).
(Shortform note: The Back of the Napkin by Dan Roam argues that drawings can solve any problems. According to Roam, solving problems with images has nothing to do with being artistic and requires no creative talent—we’re all born with the innate ability to visualize and draw what we’re thinking even if we’re convinced that we have no aptitude for it.)
Osterwalder and Pigneur suggest that you regularly create scenarios around possible future environments and the impact they will have on the way you operate. This will not only help you to prepare adaptation strategies but will enable you to generate innovative ideas for groundbreaking products and services. To create informed future scenarios, you need to understand the business environment within which you intend to operate and the various forces that influence it. The authors recommend that you base your scenarios on the following four areas of your business environment:
| Market | Industry | Key Trends | Macroeconomic |
| Market Segments: Which segments are growing or require attention? | Suppliers & Value Chain Contributors: Who do you rely on & how do they impact you? | Regulatory: Which new rules & regulations will affect how you operate? | Global Market Conditions: What overall conditions could affect your market? |
| Needs & Demands: Where are customer needs not being met? | Stakeholders: Which stakeholders influence how you operate? | Technology: Which technological trends could threaten or enable your business model? | Capital Markets: How easy is it to obtain funding? |
| Market Issues: What issues are driving change? | Competitors: Who are your competitors and what are their strengths & weaknesses? | Societal & Cultural: Which shifts or trends will influence buyer behavior? | Economic Infrastructure: How does the public infrastructure affect your market? |
| Switching Costs: Why are customers switching to competitors? | New Entrants: Who are the new players in the market and what are their strengths & weaknesses? | Socioeconomic: What are the demographic trends for your market? | Commodities & Resources: What’s the price trend for the resources you need to operate? |
| Revenue Attractiveness: What are customers willing to pay for? | Substitute Products & Services: Which products & services could replace yours? |
Risk Management Strategies
Businesses face two types of risks: preventable risks (controllable risks that you can take measures to avoid), and external risks (natural and political disasters that you can’t control). While businesses can set rules and regulations in place to manage preventable risks, external risks are more difficult to predict and plan for since they’re largely based on speculation. Further, established businesses often assume that external trends will continue in a predictable way, and they find it difficult to look beyond their assumptions when planning for the future.
However, the impact of Covid-19 on the workforce and consumer behavior emphasized that businesses are often impacted by forces beyond their control. Consequently, many experts argue that businesses need to consider how they can evaluate and manage unanticipated external risks in advance, and develop appropriate risk management strategies to lessen their impact.
Businesses can’t prevent external risks from occurring so they must focus on identifying them, assessing their potential impact, and mitigating their effects. In other words, create a recovery plan that helps you to respond effectively to external events—your objective is to shorten your recovery time and minimize potential losses.
But how can you predict the unpredictable? For the purposes of this technique, it’s beneficial to focus on early indicators of change in your environment, particularly in regards to politics, economics, technological advancements, regulation changes, and environmental forces.
For example, many businesses, both within the UK and without, are feeling the impact of BREXIT regulations, which came into force at the end of 2020. However, businesses could have taken notice of the early indicators of BREXIT (there was a call for a referendum on the UK's EU membership in 2012) and planned for the worst-case scenario. Businesses that created strategies for BREXIT’s impact on global trade ahead of the trade agreement are better prepared to respond to the additional administrative burdens than the businesses that passively waited for the deal to be finalized.
Osterwalder and Pigneur claim that creating a story centered around the value that your business model offers, from the perspective of either an employee or customer, will enable you to engage your listeners and effectively communicate your business model. You can create multiple stories throughout the process to instigate feedback and refine your business model. Further, once you’ve defined your business model, you can use the story to communicate it across your business and to external organizations.
(Shortform note: Marketing expert and author of Purple Cow, Seth Godin, argues that businesses can’t overcome resistance unless they create and frame their stories from the perspective of each audience they target. In other words, to effectively engage and resonate with your listeners, you need to recognize that each audience you address has different priorities. For example, your team cares about how your business model will affect their jobs, whereas your investors care about how they’ll profit from your business model.)
Osterwalder and Pigneur argue that prototypes of your business model will allow you to better understand the structure and combined effects of your elements. With this understanding, you can create multiple prototypes to explore and test various possibilities and strategic directions. The authors suggest that you follow this sequence to create prototypes:
(Shortform note: The sooner you test your business model, the sooner you’ll know if your business model is worth investing in. There are a number of tools that you can use to test the viability of your business model. For example, you can use targeted advertising to measure consumer interest, or use your email database to test your value offer on existing customers.)
Osterwalder and Pigneur suggest that you regularly use the Strengths, Weaknesses, Opportunities, and Threats (SWOT) analysis to evaluate the effectiveness of each of your individual elements, as well as your overall business model. The SWOT analysis provides a clear indication of the strengths and weaknesses of your current business model and reveals the opportunities and threats that you need to plan for.
(Shortform note: There are various alternatives to the SWOT analysis that the authors don’t mention. For example, NOISE would be useful when you’re actively looking for solutions to solve problems within your organization, whereas Porter’s Five Forces Model offers an effective way to analyze your competition.)
Chan Kim and Renée Mauborgne, the authors of Blue Ocean Strategy, argue that businesses need to challenge established market boundaries and business strategies to create value in new markets. The “Four Actions Framework” encourages you to shift current industry standards by examining how you can pursue both differentiation (raise standards and create new features) and low costs (eliminate unnecessary features and cut costs).
The authors argue that using this framework to analyze the impact of each of your elements will put you in a position to create demand for innovative products and services in unclaimed markets.
(Shortform note: Blue Ocean Strategy by Chan Kim and Renée Mauborgne argues that businesses can effectively bypass competition by creating entirely new markets, whereas Porter’s Five Forces argues that businesses need to continually assess their competition to remain relevant in the marketplace. Management experts suggest that a blend of both strategies can be effective—use Four Actions Framework to create your new market and then use Porter’s Five Forces to defend against your eventual competitors.)
Once you’ve defined your business model, you’ll need to evaluate if your organization is prepared to move forward with it. In addition to assessing your technology and resource requirements, the authors suggest that you consider the following questions inspired by Jay Galbraith’s Star Model to assess whether you need to restructure or adapt your business operations to successfully implement your business model:
(Shortform note: The authors suggest that you should organize all of your business operations around your business model. One criticism of this approach is that it doesn’t offer any flexibility for you to adapt your business model—every time you decide to update your business model, you’ll need to reevaluate and realign your entire organization to support your new business model. An alternative approach is to use your company values as a starting point—aligning your business model with your company’s values (instead of vice versa) will allow you the flexibility to innovate without having to evaluate your organizational structure.)
Sometimes, we get stuck on seeing things a certain way and find it difficult to think of more efficient or creative alternatives. Reframing questions can help you to challenge your assumptions to generate new ideas and solutions for your business model.
Think of one product or service you intend to offer and the customer group you intend to serve. What is the worst possible feature you could add to this product or service? What would upset your customer group?
Why would this feature upset your customer group? What problems would it create?
What if you changed your customer group or offered your product or service to a different market? Would anyone be happy to pay for this feature?
What is the complete opposite of this terrible feature? How can you use your answer to improve the product or service you intend to offer?