BUSINESS MODELS MATTER JOAN MAGRETTA PDF

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People use them interchangeably to refer to everything—so they mean nothing. But no organization can afford fuzzy thinking about these fundamental concepts. A business model and a strategy are two different animals.

Sure, the business-model concept unraveled after flagrant misuse by dot bombs. But when you build a sound model that complements your strategy, you equip your company to beat even your toughest rivals. For example, on-line grocery models failed because customers declined to pay substantially more on-line than in stores. Failing either test can prove fatal. Overloaded restaurants, long lines, frustrated patrons. Example: On-line auction giant eBay combined a compelling narrative with major profit potential.

Its narrow scope of activities creates a highly profitable cost structure. For example, sellers and buyers handle payment and shipping logistics—so eBay incurs no inventory or transportation costs and avoids credit risk. Many people—investors, entrepreneurs, and executives alike—bought the fantasy and got burned. And as the inevitable counterreaction played out, the concept of the business model fell out of fashion nearly as quickly as the.

But before managers can apply the concept, they need a simple working definition that clears up the fuzziness associated with the term. Business models, though, are anything but arcane. They are, at heart, stories—stories that explain how enterprises work. And what does the customer value? It also answers the fundamental questions every manager must ask: How do we make money in this business? What is the underlying economic logic that explains how we can deliver value to customers at an appropriate cost?

During a European vacation in , J. Fargo, the president of American Express, had a hard time translating his letters of credit into cash. If the president of American Express has that sort of trouble, just think what ordinary travelers face. Something has got to be done about it. The story was straightforward for customers. In exchange for a small fee, travelers could buy both peace of mind the checks were insured against loss and theft and convenience they were very widely accepted.

Merchants also played a key role in the tale. They accepted the checks because they trusted the American Express name, which was like a universal letter of credit, and because, by accepting them, they attracted more customers. As for American Express, it had discovered a riskless business, because customers always paid cash for the checks.

Therein lies the twist to the plot, the underlying economic logic that turned what would have been an unremarkable operation into a money machine.

The twist was float. Because people paid for the checks before often long before they used them, American Express was getting something banks had long enjoyed—the equivalent of an interest-free loan from its customers. Moreover, some of the checks were never cashed, giving the company an extra windfall.

As this story shows, a successful business model represents a better way than the existing alternatives. It may offer more value to a discrete group of customers. Or it may completely replace the old way of doing things and become the standard for the next generation of entrepreneurs to beat. Nobody today would head off on vacation armed with a suitcase full of letters of credit.

By eliminating the fear of being robbed and the hours spent trying to get cash in a strange city, the checks removed a significant barrier to travel, helping many more people to take many more trips. Creating a business model is, then, a lot like writing a new story.

At some level, all new stories are variations on old ones, reworkings of the universal themes underlying all human experience. Similarly, all new business models are variations on the generic value chain underlying all businesses.

Broadly speaking, this chain has two parts. Part one includes all the activities associated with making something: designing it, purchasing raw materials, manufacturing, and so on. Part two includes all the activities associated with selling something: finding and reaching customers, transacting a sale, distributing the product or delivering the service.

Or it may turn on a process innovation, a better way of making or selling or distributing an already proven product or service. Think about the simple business that direct-marketing pioneer Michael Bronner created in when he was a junior at Boston University. Like his classmates, Bronner had occasionally bought books of discount coupons for local stores and restaurants.

Students paid a small fee for the coupon books. But Bronner had a better idea. Yes, the books created value for students, but they had the potential to create much more value for merchants, who stood to gain by increasing their sales of pizza and haircuts.

That posed two problems. First, as Bronner well knew, students were often strapped for cash. Giving the books away for free would solve that problem. This would make the department look good in the eyes of the students, a notoriously tough crowd to please. The dean agreed. Now Bronner could make an even more interesting proposal to neighborhood business owners.

Before long, he had extended the concept to other campuses, then to downtown office buildings. Eastern Exclusives, his first company, was born. Before the spreadsheet, business planning usually meant producing a single, base-case forecast.

At best, you did a little sensitivity analysis around the projection. The spreadsheet ushered in a much more analytic approach to planning because every major line item could be pulled apart, its components and subcomponents analyzed and tested. You could ask what-if questions about the critical assumptions on which your business depended—for example, what if customers are more price-sensitive than we thought?

In other words, you could model the behavior of a business. This was something new. The business model became clear only after the fact. Of course, a spreadsheet is only as good as the assumptions that go into it. Once an enterprise starts operating, the underlying assumptions of its model—about both the motivations and economics—are subjected to continuous testing in the marketplace.

Europeans, the company thought, would spend roughly the same amount of time and money per visit as Americans did on food, rides, and souvenirs. Instead, they all expected to be seated at precisely the same lunch or dinner hour, which overloaded the facilities and created long lines of frustrated patrons.

Because of those miscalculations, EuroDisney was something of a disaster in its early years. It became a success only after a dozen or so of the key elements in its business model were changed, one by one.

Business modeling is the managerial equivalent of the scientific method—you start with a hypothesis, which you then test in action and revise when necessary. When managers operate consciously from a model of how the entire business system will work, every decision, initiative, and measurement provides valuable feedback. Profits are important not only for their own sake but also because they tell you whether your model is working.

If you fail to achieve the results you expected, you reexamine your model, as EuroDisney did. Business modeling is, in this sense, the managerial equivalent of the scientific method—you start with a hypothesis, which you then test in action and revise when necessary.

The business model of on-line grocers, for instance, failed the numbers test. The grocery industry has very thin margins to begin with, and on-line merchants like Webvan incurred new costs for marketing, service, delivery, and technology.

Internet grocers had plenty of company. Many ventures in the first wave of electronic commerce failed simply because the basic business math was flawed. Other business models failed the narrative test. Consider the rapid rise and fall of Priceline Webhouse Club. This was an offshoot of Priceline. Via the Web, millions of consumers would tell him how much they wanted to pay for, say, a jar of peanut butter. Consumers could specify the price but not the brand, so they might end up with Jif or they might end up with Skippy.

Webhouse wanted to be a power broker for individual consumers: Representing millions of shoppers, it would negotiate discounts and then pass on the savings to its customers, taking a fee in the process. What was wrong with the story? Think about that for a minute. Big consumer companies have spent decades and billions of dollars building brand loyalty. The Webhouse model teaches consumers to buy on price alone. To be a power broker, Webhouse needed a huge base of loyal customers. To get those customers, it first needed to deliver discounts.

Since the consumer product companies refused to play, Webhouse had to pay for those discounts out of its own pocket. A few hundred million dollars later, in October , it ran out of cash—and out of investors who still believed the story. In case anyone thinks that Internet entrepreneurs have a monopoly on flawed business models, think again.

In the s, Silicon Graphics invested hundreds of millions of dollars in interactive television, but it was unable to find real customers who were as enchanted by the technology as the engineers who invented it. Ultimately, models like these fail because they are built on faulty assumptions about customer behavior. They are solutions in search of a problem. The irony about the slipshod use of the concept of business models is that when used correctly, it actually forces managers to think rigorously about their businesses.

Whitman has remained attentive to the psychology and the economics that draw collectors, bargain hunters, community seekers, and small-business people to eBay.

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Summation of Joan Magretta’s ‘Why Business Model Matters’ Essay

People use them interchangeably to refer to everything—so they mean nothing. But no organization can afford fuzzy thinking about these fundamental concepts. A business model and a strategy are two different animals. Sure, the business-model concept unraveled after flagrant misuse by dot bombs. But when you build a sound model that complements your strategy, you equip your company to beat even your toughest rivals. For example, on-line grocery models failed because customers declined to pay substantially more on-line than in stores. Failing either test can prove fatal.

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What Is a Business Model?

The article indicates the differences between business strategies and business models. The author indicates that the interchangeable use of business models with business strategies has rendered the use of the terms meaningless. The author therefore enlightens the audience on the significance of a business model. She further gives an account of what causes a business model to succeed or fail. Also, the author illustrates with relevant examples, ways in which business models are complemented by an appropriate strategy. Differences between a Business Strategy and a Business Model The author refers to a business model as a story. In this case, a business model gives a description of the process through which a company generates, delivers, and puts up for sale a product or service to make wealth.

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