The Strategic Management Collection

William Q. Judge, Editor

Business
Model Design
and Learning
A Strategic Guide

Barbara Spencer

www.businessexpertpress.com
Business Model Design
and Learning
Business Model Design
and Learning
A Strategic Guide

Barbara Spencer
Business Model Design and Learning: A Strategic Guide
Copyright © Business Expert Press, 2013.
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First published in 2013 by

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ISBN-13: 978-1-60649-486-8 (paperback)

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Business Expert Press Strategic Management collection

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With assistance from R. Kellon Lawrence
 Abstract
The purpose of this book is to explain what a business model is, what you
have to do to get one, and what to do about the one you’ve already got.
It contends that to be successful, your business model must be focused
sharply on your customer. And it argues that you must think strategically
about how to use your business model if you want to gain an advantage
over your competitors.
This book is aimed at aspiring entrepreneurs and practicing managers
who want to create new business models as well as managers and leaders
who want to understand, refine, and even reinvent their company’s cur-
rent model. It is based on the premise that the fundamental purpose of
any business model is to create, deliver, and capture value. More specifi-
cally, business models describe the value proposition to the customer, the
system that must be in place to create that value, and the logics needed to
capture a reasonable share of that value for the firm. In addition, the book
shows that the core of every business model is an agreement with your
customers. If they don’t get the value they are seeking, you won’t either.
The book proceeds as follows. First, it clearly defines business models
and explains how they relate to strategy. Second, it presents seven basic
components of business models, including the customer value proposition,
key resources, key processes, the profit formula, the aspirations and capa-
bilities of key leaders, the customers and the customer relationships. These
components are then combined into three business model lenses which can
be used to explain how a business creates and captures value. As the book
proceeds, these three business model lenses are used to explore the value
creating capabilities of several companies including Bomgar, TOMS Shoes,
Netflix, Rent-the-Runway, and J.C. Penney. Each story provides lessons
and implications related to effective business modeling and strategy.

Keywords
business model, business model components, business model lenses,
customer value proposition, value appropriation, profit formula, target
customer, customer perceived value, customer value agreement, customer
value relationship, business model experimentation, business modeling
 Contents
Chapter 1 Why Business Models Matter .........................................1
Chapter 2 Three Business Model Lenses .......................................13
Chapter 3 How the Bomgar Box Delivers
Customer Value ...........................................................27
Chapter 4 A Ham Radio Company Builds a Superior
Business Model ............................................................39
Chapter 5 TOMS Shoes: Selling a Vision .....................................49
Chapter 6 Netflix Cancels the Value Exchange Agreement ............61
Chapter 7 Rent the Runway: Changing Customer
Behaviors and Industry Norms .....................................69
Chapter 8 J.C. Penney’s Big Experiment .......................................79
Chapter 9 Ten Key Ideas About Business Models .........................93
Appendix A: Pricing Mechanisms .........................................................105
Appendix B: Online Marketplaces ........................................................115
Notes...................................................................................................119
References ...........................................................................................127
Index .................................................................................................135
 CHAPTER 1

Why Business Models

Matter
Recently, I flew home from Canada after attending a conference. As a
relatively frequent flyer, I was happy to be upgraded to first class and
as my flight was at noontime, I was looking forward to a nice meal on
a white tablecloth. To my surprise, on a two-hour flight, all I got was a
beverage and some peanuts. When we landed, I found that my luggage
had not arrived. As I waited in line to fill out the paperwork, I was not a
happy camper.
Why is it that flying anywhere so often turns out to be a frustrating
experience? In his blog, Patrick Stähler contends that the airlines are facing
problems because their business model is broken.1 Neither the customers
nor the firms are receiving the value they seek. He reports that in the years
following 2000, the average airline generated an EBIT margin of just 0.7%
while thousands of passengers posted their disgruntled stories online.
According to Stähler, airlines have created this state of affairs by
training their customers to search multiple channels for the lowest possible
price, regardless of the fact that the experience that comes with such a
price is likely to be unsatisfactory.2 We customers play along because we
know that prices go up and down, and because we have the power to
search out good deals on the Internet. Indeed, we feel taken when we
find that a better price was available on a different website, or at a later
date. We’ve continued to play along even though we’ve had to forgo our
free meals, squeeze into ever smaller seats, and carry on our bags to avoid
fees for checking in our luggage. And just as we learned to put all of our
one-ounce cosmetics containers into one-quart plastic bags, we faced new
charges for carry-on luggage. Each change feels like a kick in the teeth.
They were not part of the bargain. We feel ripped off. Our experience of
value has deteriorated.
2 BUSINESS MODEL DESIGN AND LEARNING

In this case, neither the customers nor the airlines are satisfied with
the value they are receiving. In contrast, a successful business model
is based on an agreement between a company and its customers—an
agreement that all parties will get what they need. It is an agreement
about the fair exchange of value that should take place when two par-
ties do business together. This agreement may not be stated out loud or
written clearly, but it frames our expectations and reactions. When it is
violated, customers become angry, firms lose profitability, and indus-
tries spiral downward. In the airline example, both the firms and the
customers are dissatisfied with the value they are receiving. It may be
time for a new model.
Stähler contends that the airlines have focused too much on keeping
up with their competitors and too little on their relationship with their
customers.3 They have allowed their product to be defined as a commod-
ity as opposed to exploring new pricing models and sensible alternatives.
To put it another way, they have focused too much on strategy and not
enough on providing customer value. As a result the customer relation-
ship has become increasingly hostile, while internal changes have contin-
ued to focus on cutting costs, reducing seat sizes, and adding new charges
for luggage and food. Real change will require dialogue with custom-
ers and explicit examination of tacitly held assumptions. Or it will come
from an upstart with a new way of looking at things.
The purpose of this book is to explain what a business model is, what
you have to do to get one, and what to do about the one you’ve already
got. I will argue strongly that your business model must be focused on
your customer—like a laser—if you are going to be successful. And that
you have to think strategically about how to use your business model to
gain an advantage over your competitors. It’s a dog eat dog world. Customers
have lots of choices.
On the other hand, I believe that this is a great time to go into business.
Gaining access to customers, while still tough, is easier than ever before;
new online marketplaces allow you to sell your products right beside the
big guys. And there are many new ways to price your services and get paid
for your work: from subscriptions, to paywalls, to Paypal. You can even
swipe credit cards on your iPhone.
 WHY BUSINESS MODELS MATTER 3

This book is written both for people who may want to start a business
and for those who work for one and want to make it better. People in
both situations have much to gain by clarifying their understanding of
business models and putting that knowledge to work.
In the next section, I will explain what a business model is and what
it isn’t. I will talk about the differences between business models and
strategy, and the relationships between business models and strategy.
Finally, I will explain what it means to think strategically about your
business model.

What Is a Business Model?

A business model is a tool or a framework that can assist you in figur-
ing out how you can use what you’ve got to make something of value
for a customer while making money for yourself.4 It is the way a system
of activities comes together to create a product or service offering and
deliver it to the customer. A good business model clearly explains the
core logic behind the system, how it all works together to create and
capture value.5
Every business model is framed around a customer value
proposition which is your idea of how you will provide value to your
customer. A value proposition is an educated guess that what you are
offering will be valuable to the customer. In fact, the entire business
model is like a theory about how your company can meet customer
needs, and get paid for doing so.6 You don’t know if it will work
until you try it. It is also true that the best models are like narra-
tives7—you need to be able to explain how all the parts are going to
come together to produce this thing that the customer will love. And
you also need to explain how you will get revenues by doing so. Will
the customer pay for it? Will you sell advertisements? Will you use
subscriptions?
The fundamental purpose of business models is to create value for
both your customer and your firm.8 You have to give your customers
what they want, even if they’re not quite sure what it is. And you have
to do it in such a way that they will choose your firm instead of your
4 BUSINESS MODEL DESIGN AND LEARNING

competitor’s. When that happens, an exchange agreement, or a relation-

ship, is formed between you and your customers. You need the revenues
that they provide and they need the product or service that you offer.
Your job from this point forward is to nurture the relationship and adapt
as needed in order to keep it strong. This is complicated because the
customers can leave at any time. You can’t control them so you have to
make them happy.
Eventually, assuming the business gets off the ground, the model will
become built into your company. It can be found in the way that you
manufacture your products, the type of employees you hire, the brand
that you choose, and the policies that you set. Often, this side of the
business model is hidden or unclear to organizational participants. People
come and go. Time change. Eventually, no one remembers why certain
things are done the way they are. The reasons for many past decisions
are passed off as tradition. To revitalize your company and your relation-
ship with your customers, you should take a hard look at everything you
do and ask yourself how it contributes to building or capturing value.
Chances are that you will find some things that no longer make sense.
Perhaps they used to be valuable, but now they’re not. Learning to make
your business model explicit is a big deal. It is often the first step to
improvement or change.

Three Business Model Lenses

In my mind, a business model is like a lens—its purpose is to help you
see things more clearly.
If you refocus the lens, you can see something different. On the
basis of this simple idea, I describe a business model concept that has
three lenses based on three levels of complexity. Each level builds on
the one beneath it and adds to what you see when you apply the
model. The three levels are:

1. Foundation level business model

2. Differentiated business model
3. Adaptive business model
 WHY BUSINESS MODELS MATTER 5

Foundation Business Model

As I said earlier, the most basic purpose of a business model is to create,

deliver, and capture value. So the foundation of any business model
is putting into place the processes and activities needed to provide an
offering to a customer and earn a profit. These basic business model
activities are necessary for establishing operations but insufficient to
assure competitive advantage. They are often transparent and easy to
copy, and as a result, they are often shared by multiple competitors.9
The foundation level is a fairly generic model regarding what the business
is and is not, and ensuring that the pieces fit together to serve the cus-
tomer.10 As such, it permits general comparisons across ventures and
also is easy to imitate. The foundation business model does not focus
on the competition.

Differentiated Business Model

Once you have established a basic system for providing and capturing value,
the next step is to ensure that you can attract customers to your offering
versus those of competitors. This means that you have to think strategi-
cally about your business model and your customer value proposition and
build in some ways of ensuring its uniqueness.11 In other words, you will
need to figure out how to build a competitive advantage into your model.
This requires providing value that customers perceive as novel, or better, or
cheaper than that offered by the competition.12 And it requires building in
means of protecting those novelties from easy imitation.

Adaptive Business Model

Once you gain a customer base, your business model should become
more complex. The adaptive business model lens incorporates your
customers and your relationship with customers into the model.
Incorporating your customers into your thinking about your busi-
ness model will help you to maintain its viability over time.13 Adapta-
tion requires listening to customers and reconsidering what it means
to provide them with superior value. It requires learning from your
6 BUSINESS MODEL DESIGN AND LEARNING

customers. In addition, by using this model, you can see ways to use
your customer base as a resource. By recognizing and utilizing this
resource appropriately, you can sustain and even renew your model
over time.

Business Models Versus Strategy

In comparing the idea of a business model with the idea of a strategy, the
big difference is that a strategy is a broader concept. But business models
come first. To put it simply, a business model is a necessary but not
sufficient ingredient of your strategy. Putting together a viable business
model will get you in the game. However, once competition comes along,
you probably won’t get far unless you have a strategy about how to serve
your customers better than your competitors.
Strategy describes how a firm competes or differentiates itself from
others.14 According to Michael Porter, strategy involves carrying out
different activities than your competitors, or accomplishing similar things
in different ways. The bottom line is that strategy is always considered
relative to your competitors.15 Competitive advantage means that you are
doing something better, either to create more value for your customers or
to capture more value for the firm.
When you create a basic business model, you are developing logic
for bringing resources and processes together to generate value for your
customers while making money. Strategy is not necessarily involved at
this point. And yet, you can only survive without a strategy if there are
no competitors in the picture. If you do have competitors, then you must
build some differentiators into your model. To this end, you will have
to think strategically about how to provide value to your customers that
is better, or newer, or cheaper than that provided by others. Your business
model then begins to reflect your strategy. And yet, it also limits the kinds
of strategic decisions that you can make.
As a simple example, consider the grocery store business. At the founda-
tion level, grocery store business models are based on bringing together an
array of foods and household goods in a physical location where customers
can come, choose what they want, and pay. The basic value proposition is
to provide customers with access to affordable food and beverages and
 WHY BUSINESS MODELS MATTER 7

other articles for your home. Essentially, you are giving your customers
convenient access to desired items at a good price. Profit margins, in this
industry, have traditionally been quite thin.
When you consider ways to differentiate grocery stores, you have
many choices. You can provide a broader variety of foods in a more
pleasant setting, or a narrower variety of foods at a lower price. You can
enhance the services provided or you can have customers do more of the
work themselves. There are many ways to build differentiators into the
model.
For example, consider how the German firm, Aldi, competes against
more traditional supermarkets. Aldi’s relatively small stores carry a nar-
row range of core, high volume grocery items, usually in one size and
one brand.16 You may find different choices on different visits. Products
are stacked in boxes, on pallets. There are no meat counters or fresh
produce. Prices are rock bottom low but costs are low enough to offset
this pricing scheme. All of the pieces of the model are self-reinforcing.17
Obviously, Aldi is still using a basic grocery store business model.
Customers drive to the store, load up their carts with food and sundries,
pay, and depart. But now that model has been tweaked to generate more
profit and draw in a particular set of customers. Strategic choices have been
built into the business model to generate a slightly different value proposi-
tion, and sophisticated processes have been designed to slow down imita-
tion and enhance efficiency.
Business models are not strategies. Business models are the foundations
for strategy.18 They are also the reflections of a firm’s realized strategies.19
Entrepreneurs and managers should think strategically about their business
model and build in features and processes that set them apart from com-
petitors. Yet these strategic choices are constrained by the basic business
model you started with. And the focus must always be on creating value.
So the bottom line is this. A business model is a tool or a concept that
will help you to build or analyze your company. Your business model is also
reflected in the systems and processes that you put into place to create and
deliver value to your customers and to capture value for your firm. It is the
foundation on which you will build your strategy. A strategy is a plan or
position that distinguishes your firm from competitors who may very well
have the same business model.
8 BUSINESS MODEL DESIGN AND LEARNING

You can use the business model lenses described in this chapter to
help you assess the elements of your business model and to seek ways
to build in differentiators that will provide your customers with better
value than they can get from others. Moreover, when you think strategi-
cally about your business model, you may find ways to build systems and
processes that are hard for others to replicate and that may increase your
bottom line.20
Strategic thinking about your business model is an ongoing require-
ment. The issues faced in building a brand new model are very different
from those that you must think about when your model has matured and
new competitors are at your door. To be successful, you must constantly
be learning, adapting, and evaluating your decisions and activities.

Value Exchange Relationship

The objective of your business modeling efforts is to create a sustain-
able exchange of value with your customers. This occurs when both
parties are getting something of value. It’s a balance between the value
provided and the value received. Once you get this relationship going,
you have to take care of it. As any married person will tell you, it’s one
thing to start up the fire, but it’s another thing altogether to keep it
going. You have to be mindful of the flame itself, as well as everything
that is going on around it.

Value exchange

Firm Customer Customer

leadership value aspirations
and logic proposition and needs

Figure 1.1. Value exchange relationship.

 WHY BUSINESS MODELS MATTER 9

The following questions will help you think about this value exchange
relationship.

1. What do you mean by value? Business models exist to create and

deliver value, both to a customer and to the firm. Therefore, you
should begin your thinking about business models by thinking
about value. What type of offering will you be bringing to the market
and what are its features? How will it be accessed? How will it help
someone to achieve a goal or solve a problem?
2. For whom will you create value? Who are the customers that will
need or want your offering? Where are they located? How will you
find them and reach them? What needs or aspirations or problems
do they have and what features do they prefer?
3. How will you create value for the customer and make money
doing it? What is your value proposition and what system will
you put in place to make this happen? How will you build your
deliverables and brand your products? And how will you manage
your costs in order to meet the profit criteria you’ve established?
4. How can you provide better value than the competition? What fac-
tors will distinguish your offering from those of other firms? How is your
offering different, or better, or cheaper to buy? What are your sources of
advantage and how can you protect them from theft or imitation?
5. How can you strengthen your customer relationships? Once peo-
ple start buying your offering, what will you do to keep them coming
back? How can you enhance the link that ties you together? Can you
put processes in place to enhance the social or emotional compo-
nents of your connection?
6. Can you change? Can you adapt to customers’ changing perceptions
of value as new technologies and new business models change the
game? Can you evolve completely or begin again? It is likely that even
successful business models will need to be revamped or abandoned
at some point.21 Can you remodel? Remodeling refers to a complete
transformation of a model and reformulation of a new design. It
may require you to change your perspective and consider radically
new concepts. It may even be best at times to sell the business and
begin again.
10 BUSINESS MODEL DESIGN AND LEARNING

Testing Your Hypothesis—Four Evolving Concerns

As I mentioned earlier, every entrepreneur or new business starts out with
a hypothesis about the customers and the market, and then develops a
business model in alignment with that hypothesis.22 Most likely, your
initial model won’t be fully formed and you will have to refine it repeat-
edly as you try it out.23 First, you need to determine whether you can
make it work at all, and then you have to figure out whether you could
make money with it. Ultimately, you will never know if your business
model is going to work until you’ve tested it with real customers paying
real money. Johnson, Christensen, and Kagermann state that successful
new businesses typically revise their business models four times or so on
the road to profitability.24
Feasibility and viability are the two basic concerns that you must
address when you stand up your initial model. Will it work? Can
you meet your promises to customers? Will they find your offering to
be valuable? Will they be willing to pay some money to get it? These
questions must be asked by all new entrepreneurs. And they are often
addressed in an iterative fashion with small steps and experiments and
occasional injections of cash.25 They sometimes require luck and intui-
tion as you try to figure out what will work. And they always require
advice and assistance from as many of your friends and acquaintances
as you can draw in.
Sustainability relates to the longer term. Once you are selling some-
thing and generating steady revenues, you must shift your focus toward
bolstering your relationship with your customers, and differentiating your
firm from new entrants. Key questions involve how you can provide value
that is superior to the competition and how you can ensure that custom-
ers remain interested over time.
Adaptability is a continuing concern. Over time, you will have to
revise or evolve your model; worse yet, you may even have to rethink
your initial assumptions and make radical changes in the way you do
business. You might also choose to harvest your resources and invest them
in new ventures and spin offs. Adaptability involves knowing the limits
of your current design and sometimes making the hard decision to start
all over again.
 WHY BUSINESS MODELS MATTER 11

Summary and Conclusions

In this chapter, I introduced the business model concept, distinguished it
from strategy, and introduced three different business model lenses that
can help you focus on specific elements of your value creation and capture
system. I argued that the development of a business model should be
based on strategic thinking, and that you can build differentiators into
your model to set it apart from others. I also argued that the business
model by itself is not strategy. It is both the foundation for your strategy
and a reflection of your strategy-making processes. Finally, I introduced
four business model tests that must be passed if your model is to generate
value for you and your customers.
These are complex ideas, but I will continue to revisit them throughout
this book by sharing stories about how some business models were built,
why they work, and sometimes, why they fail. I’m also going to look at
the strategies used by people to build their business models, as well as
the actions they have taken to sustain them over time, or to change them
completely.
In order to frame these stories and clarify the core logics connecting
the business models, I will use each of the three business model lenses: the
foundation business model, the differentiated business model, and the
adaptive business model, as appropriate.
In the next chapter, I will introduce each of the business model lenses
in graphic form and I will explain their major components.
 CHAPTER 2

Three Business Model

Lenses
Until recently, people didn’t use the term business model at all—they
were built into the way we did things, but they were not openly discussed.
Several things came together to change this situation. First, was the
growth of business outsourcing, which started in the 1970s and 1980s.1
Until that time, most large companies controlled their entire value chains
from raw materials to distributors, and they were diversified across prod-
ucts and markets. When global competition began heating up, these large
enterprises were fat and slow.2 They had to find a way to simplify their
operations.
Some companies slimmed down by outsourcing certain functions
that weren’t part of the core. For instance, L. L. Bean has outsourced
the printing of its catalogs for many years. Next came the outsourcing of
administrative support services. Eastman Kodak raised eyebrows when
it announced the outsourcing of its information technology systems in
1989, but, these days, a new crop of business service providers, including
Accenture, makes a lot of money by providing processes from account-
ing and billing to employee selection and hiring. Today, some companies
even outsource their core functions, including manufacturing. There are
plenty of companies out there waiting to do that for you. These new ideas
about different ways of organizing have also led to new thinking about
business modeling.
The availability of spreadsheets for analyzing your numbers has also
contributed to our new fascination with business modeling.3 Now, when
you are trying to figure out what parts of the process to do yourself and what
14 BUSINESS MODEL DESIGN AND LEARNING

parts to do with partners, you can do what-if analyses. This is important

when you are working out your profit formula—a crucial part of any
business model.
Finally, both the growth of the Internet, and the movement of
business online have led to the emergence and study of new e-business
models.4 These new models have undermined many traditional industries
by providing a new level of customer value.5 For example, Amazon.com
changed the way people shop and challenged many traditional retailers
by allowing customers to purchase goods from home. Today, Amazon
is still blazing a trail with ongoing innovations in its business model,
ranging from the Kindle and the amazing growth of online publish-
ing to the addition of online marketplaces, which lower the barriers
to entry for new companies seeking a way to get their products in
front of their customers. Similarly, Blockbuster’s recent demise came
about after Netflix fundamentally changed our perception of how to
watch movies at home, first through delivery to your mailbox, after
ordering online, and then by providing us with video streaming on
demand. Owing to innovations like these, traditional business models
are under attack, and new ones are constantly being contemplated and
implemented.
Yet, the resounding failure of some of these new e-business models
has added even more fuel to the fire. How can companies exist with
no revenues? How can we charge for online information and services
that customers expect to be free? New pricing mechanisms have become
major topics of discussion and experimentation. Even today, we don’t
pay directly to use Google’s powerful search engine but the company
could not survive if it hadn’t been able to figure out how to generate
revenue flows.
Thus, with the movement of firms to the Internet, companies have
begun to think much more explicitly about the value created and captured
by their business models. Even firms that do only part of their business
online have had to rethink their distribution decisions, if not their entire
business models.6 And with the increasing interconnectedness of markets,
some companies can move, and grow, extremely fast. Consider Groupon,
which came into existence in 2008 and went public in 2011, with a mar-
ket value over $17 billion.7
 THREE BUSINESS MODEL LENSES 15

Today, business models are frequent topics of conversation and

concern. In the next sections, I define what a business model is and
describe its elements.

Business Model Definition and Elements

Cantrell and Linder have said that what many people call a business
model is really only part of a business model.8 I agree. Consider how one
recent online post described three types of business models: bricks and
clicks, bait and hook, and subscription.9 This is overly simplistic. The key
to remember is that a business model is not just a pricing mechanism, or a
logistics chain, or a slogan; instead, it is the entire system of resources and
processes that you will put in place to create and capture value.
Today, some excellent blogs and columns are being written online
about business model development and innovation. Some of the leaders
are Clay Christensen, Marc Johnson, Alex Osterwilder, and Steve Blank.
I have included references to their work at the end of this book. A growing
number of academic articles also are being published on this topic, includ-
ing important articles by Magretta, Teece, Schweizer, Chesbrough, and
many others. In their comprehensive review of the business model litera-
ture published in 2011, Zott, Amit, and Massa concluded the following:

1. The business model is emerging as a new level of analysis. It is different

from strategy.
2. Business models take a system-level holistic approach to explaining
how firms do business.
3. Firm activities play an important role in how business models are
carried out.
4. Business models explain how value is crafted, not just captured.10

In other words, we create business models to explain how firm resources and
activities come together as a system to create and capture value. To design a
business model, we have to decide what we mean by value (for both our
customers and ourselves), and we have to figure out how to bring together
the elements needed to make it happen in such a way that it will not easily
be duplicated or outperformed.
16 BUSINESS MODEL DESIGN AND LEARNING

One perspective that has been particularly useful in my own under-

standing of what belongs in a business model is from Johnson, Chris-
tensen, and Kagerman.11 Johnson wrote more about this model in his
book Seizing the White Space.12 According to these authors, a business
model consists of the following four interlocking elements that, taken
together, create and deliver value:

• Key resources are things that you will use to build your business
model and the way in which you will get them.
• Key processes are the routines and capabilities you will use to
turn your resources into something of value for your customers.
• The profit formula is how you evaluate whether you can
make money on the things you are doing to deliver value to
your customer.
• The customer value proposition explains clearly what
benefits you intend to provide to your customer through your
product or service offering.13 It is the most important of the
four elements.

Taken together, these four components provide the initial ingredients for
business modeling, but I contend that you can refine your ideas by adding
three additional pieces to the mix.

• The entrepreneur or firm leaders’ goals, aspirations,

and capabilities. Every entrepreneur or leader comes to
the business with personal aspirations and values as well as
particular ambitions related to time, scope, and size of the
enterprise.14 In addition, each company leader has highly specific
experience and education, which shape his methods of bringing
together a business model. If we provide two packages of
identical resources to two different people, they are likely to
come up with very different models based on their personal
capabilities and goals. This explains why venture capitalists
are always much interested in the founder’s experience and
drive when they consider whether to fund a start-up. It is
this person, or team, that makes everything happen, at least
 THREE BUSINESS MODEL LENSES 17

at the beginning. As a result, you should begin your business

modeling by doing some deep reflection on your own goals
and capabilities.
• The customers. Most business model formulations talk about
the importance of the customer as the receiver of value and
provider of revenues, but they do not include the customer
in the model.15 Osterwilder includes the customer as one of
the nine components of his business model canvas but only as
the target of the value proposition and generator of revenues.
Customers are not involved as part of the infrastructure
or in the definition of the offer.16 However, Chesbrough17
talks about open business models in which various partners,
including customers, participate in the innovation process.
In addition, some marketing researchers have begun looking
at coproduction in which the customer participates in the
creation of the core offering itself.18
• The relationship between the firm and its customers. Once
the firm has established the exchange of value with customers,
a relationship is formed. This relationship must be nurtured
and cared for if it is to be sustained.

The next section shows how these components can be brought

together to form three different business model lenses including the
foundation business model, the differentiated model, and the adaptive
business model.

Three Business Model Lenses

Figure 2.1 shows the business model foundation, which includes the four
elements described by Johnson, Christensen, and Kagerman and the firm
entrepreneur or leadership team in the middle.
In the first stage of business modeling, the goal is to figure out how to
combine resources and develop processes to generate a value proposition
that will benefit your customers while also generating a profit for you.
This lens focuses only on the elements of the business that you have to
work to create and capture value.
18 BUSINESS MODEL DESIGN AND LEARNING

1. What capabilities do we need to

make or sell our offer?
2. Should we do these ourselves, or
outsource them?

Key
processes
1
1. What features will we
1. What resources do we offer our customers?
need to make or sell 2. At what price?
Firm
our offer? Key Value 3. How will they access it?
aspirations
resources proposition 4. How will they experience
2. Do we control these, & goals
or do we get them the product and the
from partners? purchase interaction?

Profit
formula 1. What margins do we need?
2. What are our overhead costs?
3. What is the breakeven volume?
1. What is our vision for this
business?
2. For ourselves?
3. What skills do we bring
to the table?

Figure 2.1. Foundation business model lens.

The customer value proposition is the most important part of your

business model foundation. You can think of the value proposition as
a hypothesis on how you will provide and deliver value to customers. In
fact, at the beginning, your whole business model is like a theory of how
all the pieces will come together to create and capture value.
Creating an attractive value proposition is tricky because sometimes
your perception of benefits provided and the customers’ perception of
benefits received may be very different. Only the customer can decide if
something is really a benefit.19 And many would-be entrepreneurs have missed
the mark. I recently read about a man who opened up a day care center for
cats. As a cat owner, I can’t imagine how anyone could have believed that
would work. The point is that your initial business model reflects your
hypothesis about what customers want, and you will never know whether
it is going to work until you test it. Of course, the better you know your
customer, the better your proposition is likely to be.
You need access to key resources and the ability to carry out key
processes in order to bring your value proposition to life. In fact, your
whole idea may have come about because of access to a key resource
or experience you’ve had with a particular process. For instance, you
 THREE BUSINESS MODEL LENSES 19

may have a patent on a new product design or you may have inherited
some money. A generic list of resources includes things such as people,
technologies, products, equipment, channels, and established brands;
however, almost anything can be a resource if you have an open mind
or a good imagination. Your family name can be a resource if it is well
known, and your relationships with friends or even your social networks
can be resources as well.
Key processes are things that you know how to do, or to get done.
These include all the processes you will use to make things and sell
things. How will you manufacture? How will you advertise? How will
you deliver the products? How will you develop and motivate your
employees?
As you consider the resources and processes needed to create your
value proposition, a key question to ask time and again is: What activities
should be carried out inside or outside the company? What can you do by
yourself and what should be outsourced? This is a fundamental decision
in business modeling.
At this point in modeling your business, you also have to take a good
hard look at yourself and your leadership team. What skills do you bring
to the table? What limitations do you have? Have you considered these
strengths and weaknesses in conjunction with your assessment of key
resources and processes? In addition, what are your long-term goals? Are
you in this business for the long run or are you trying to build and sell
quickly? And, of course, what is your vision for the firm itself? Are you
striving to create a local institution, or to achieve global dominance?
The better you understand these driving forces, the stronger your lead-
ership will be. In addition, knowing what you are trying to achieve in
the long run will help you clarify your thinking about your economic
objectives.
The profit formula portion of the foundation model requires you
to think specifically about how you are going to make money for your
company. To answer this question, you need to consider your sources
of revenue, whether from sales, advertising, subscriptions, or some
combination. Once you know where the revenues are coming from, you
must consider three essential elements: your margin, your overhead, and
your required breakeven volume.
20 BUSINESS MODEL DESIGN AND LEARNING

The margin is the price you charge for a product or service minus
the direct costs of producing it. Direct costs include the cost of labor
and materials used to make the product or carry out the service. Next
is overhead, which are the costs you incur regardless of whether you sell
anything or not. These include rent, electricity, administrative support,
and so on. David Newton refers to this as the burn, or the money that
will be spent regardless of the level of production.20 Finally, breakeven
volume is the number of products a firm must sell at a given margin
(price–direct costs) to cover the overhead costs of the firm. If you fail
to meet this breakeven volume, then your firm will incur a loss for a
given period.
At the end of this stage of modeling, you should have an idea that is
ready to be tested. You will know that it works if customers are willing to
pay money to get your offering, and if you find that you could maintain
your operations based on that revenue flow.
Note that the business model foundation includes the customer
value proposition, but it does not really include your relationship with
your customer. Again, this is because the business model foundation is
a hypothesis. Once this design is laid out, it must be tested to see if it
attracts customers. You will need to promote, experiment, and revise your
approach until you have enough evidence to support the idea that people
will really be willing to buy your product at a price that will cover your
costs and produce a profit.
One other thing that is missing in your business model foundation is
a way to differentiate your offer from competitors. Differentiation is not
built into this foundational model and so it is fairly easy to replicate.21
Figure 2.2 shows a model to be used in the second stage of business
modeling—the differentiated business model.
While the foundation model captures the essence of the business model
for many firms, sustainable competitive advantage depends on the addition
of unique approaches and difficult-to-imitate processes to one or more of
the foundational components.22 Thus, loop 2 represents the addition of
differentiators to the foundation that will provide the customer with some-
thing that is better or cheaper, or just plain newer, than competitive offer-
ings. In addition, this level of the model requires you to think about how
to provide value in such a way that it cannot be easily copied.
 THREE BUSINESS MODEL LENSES 21

1. Do we have access to processes

that others cannot imitate?
2. Can we combine processes and
resources in ways that others cannot?

Key
processes
2 1

1. How does our value

Firm proposition provide more
1. Do we have access to
Key Value benefits, or impose a lower
resources that others aspirations
resources proposition cost, on our customers
cannot reach? & goals
than those of similar
competitors?

Profit
formula

1. Can we reduce costs more

than competitors?
2. Charge a higher price
than competitors?

Figure 2.2. Differentiated business model lens.

Examples of questions to be added to your business modeling at this

point include the following:

• How does our value proposition provide more benefits, or

impose fewer costs, on our customers than those of similar
competitors?
• Do we have access to resources that others cannot reach?
• Do we have access to processes that others cannot imitate?
• Can we combine our processes and resources in ways that
others cannot?
• Can we reduce costs more than competitors?
• Can we charge higher prices than our competitors?

Separating the business model foundation from the differentiated busi-

ness model is actually an oversimplification. Obviously, some business
models are built in a unique way from the very beginning. In fact, if you
are planning to enter a market in which competition already exists, then
you must build differentiators into your model from the very beginning,
or it doesn’t even make sense to do it. However, in other cases, it makes
22 BUSINESS MODEL DESIGN AND LEARNING

sense to experiment with your basic model operating system before

messing with differentiators, just to ensure that you’ve got something
that works.
If your business model is different enough, you may find that your
approach may come to change the way business is done in a particular indus-
try, as Apple did when it turned mobile phones into portable computers. Or
you may establish a completely new niche by adding value where there was
none. This is what Kim and Mauborgne called a Blue Ocean strategy.23 It
means opening up a whole new market and escaping the bloody red market
that is saturated with competitors. This is what Nintendo did by designing
its Wii gaming console for people who were not current video game users.
Thus, there will always be cases in which loops one and two are com-
pressed. I have separated them here only to make it clear that one should
think about creating and capturing value (loop 1) and think about doing
these things differently from competitors (loop 2). Both considerations
are highly important.
Your initial goal in building a business model is to make something
that your customers want to buy. Once this happens, you can start earning
money. But your thinking can’t stop there. You also need to give them a
reason to buy from you rather than anyone else.
Once the system is established, and once customers begin paying for
the offer, the third stage of business modeling begins. At this point, you
can use another business model lens to stimulate your thinking. This lens
adds two new elements to your business model—your customer base and
your relationship with your customer. The adaptive business model lens is
shown in Figure 2.3. It includes the foundation and differentiators as well
as the exchange relationship connecting the customer to the firm.
The model in Figure 2.3 is called an adaptive business model because it
focuses your attention on your customers and your ongoing relationship with
them. The value exchange relationship is like the engine that propels your
business model forward. It is initiated by providing deliverables that your cus-
tomers appreciate and are willing to purchase, and it is fueled by your firm’s
ability to capture those payments and reinvest them in the system.24 Without
attention and consideration, this newly hatched relationship can expire.
Your relationship with customers is actually a social agreement
indicating that both parties want to do business together. You agree to
 THREE BUSINESS MODEL LENSES 23

1. How can we facilitate customer

to customer communication
and learning?
2. How can we learn from our
customers?
1. How satisfied are our
customers with our
Key offering?
processes 2. How satisfied are
2 1 customers with our
relationship?
3. What long term goals and
Firm concerns are driving our
Key Value Customer
aspirations aspirations customers? Can we
resources proposition & goals assist?
& goals
4. What current concerns or
costs do our customers
still face even when using
our product?
Profit
5. What new alternatives or
formula
substitutes are selected by
customers when they
leave us?

Figure 2.3. Adaptive business model lens.

provide the value that they seek, and they agree to purchase. Revenues
generated by this exchange agreement are crucial to the business—but
customers are fickle and their perception of value may shift in the blink
of an eye. To maintain this relationship, you must adopt specific actions
and processes to help you to stay in sync with emerging customer atti-
tudes and behaviors. Throughout this book, I give examples of com-
panies that have done this very well, and companies that have done it
poorly or not at all.
Companies that consider their customers and customer relationships
as part of their business model can gain advantages that others miss. These
days, it is well known that customers not only generate value in the form
of revenues, but they can also help coproduce products and services, assist
in promoting and selling your offer to others, and stimulate new ideas for
ongoing innovations.
Questions to be addressed in this model include:

• How satisfied are our customers with our offering?

• How satisfied are our customers with our relationship?
• What long-term goals and concerns are driving our customers?
Can we assist?
24 BUSINESS MODEL DESIGN AND LEARNING

• What current concerns or costs do our customers still face

even when using our product?
• What new alternatives or substitutes are selected by customers
when they leave us?
• How can we facilitate customer-to-customer communication
and learning?
• How can we learn from our customers?

Modeling Your Business

The foundation business model lens can be useful when you are first
developing your business model, and you simply want to focus on how
you will create value for a customer and capture value for your firm. It
can assist you in generating your theory or hypothesis about how your
offering will provide customer value.25 It also includes a profit formula
component to stimulate you to think specifically about the revenues you
will need to gain, as well as how to keep your costs in line so that you can
make a profit. Overall, the key is to build a concise, logical description of
how the different parts of the business will come together to create value
for the customer and make money for the firm.
Once you have figured out how the parts should work together to
generate value, you will need to test your ideas for feasibility and viability.
That is, does it work as planned? Will people buy it? While you are
building the foundation of your business model, you should be constantly
experimenting and testing to see what works. You’ve got a theory about
how to generate and capture value and you need to test it to see if it will
do what it is supposed to do, and if it will attract paying customers.
If this pans out, you also need to be sure that you can differentiate
your offer from those of competitors and take steps to avoid imitation.
The differentiated model is based on the premise that you must provide
customers with superior value—so that they will choose to buy from you
versus another supplier. You will need to build differentiators into your
model to gain an advantage over your competition.
Finally, you need to consider ways to nurture and sustain the value
exchange cycle that you have created with your customer base. Specific
processes and policies will be needed as you grow. The adaptive business
 THREE BUSINESS MODEL LENSES 25

model lens brings your customer into your business modeling processes
once a relationship has been established. Your customers can be consid-
ered a resource that you can draw upon as you adapt your model over
time. In addition, you will need to consider ways to nourish and sustain
customer relationships. This may eventually lead to reconsideration of
initial modeling decisions. Taken as a whole, the adaptive business model
lens is a tool that can help you sustain and renew your business.
As an entrepreneur, you can use these lenses to begin modeling your
business idea. If you work for a business, you can use them to clarify the
core logic behind your company’s value proposition. You should be able to
tell how you will make things, how you sell things, and how these activi-
ties can generate value for your customers and your firm.26 Just think of it
as a story. If you can’t tell it simply, as a narrative, it’s probably broken.27

Summary and Conclusions

In this chapter, I described changes in the business environment that have
contributed to the growth in thinking about business models; I introduced
seven key components of business models; and I used these components
to create three business model lenses. These included the foundation business
model lens, the differentiated business model lens, and the adaptive business
model lens.
Each of these lenses is based on the premise that, to be effective, a
business model must be built in a way to create, deliver, and capture
value. Before delving further into the modeling process, we need to take
a closer look at what we mean by value. Chapter 3 suggests that value is
best understood from the perspective of the customer.
 CHAPTER 3

How the Bomgar Box

Delivers Customer Value
Every business model is built to attract paying customers. It does this by
creating and delivering something that they value. And value, it turns
out, cannot be objectively defined or determined except through the eyes
of the customer.1 The idea that value is subjective is an important one. It
literally means that your product or service will have no value unless some
customers somewhere believe that it does.
Customers view products or services to be valuable if they help them
to accomplish a goal, solve a problem, increase a benefit, or reduce a
cost. Something is even more valuable if it helps them to accomplish
several of these at once, such as cleaning the kitchen without harming
the environment; or dressing fashionably while saving money. Thus,
to generate an attractive value proposition, you have to figure out who
are the customers, what do they want to accomplish, and what are the
sacrifices that are currently associated with getting it done.
Joel Bomgar didn’t have any of these problems. His highly successful
product, the Bomgar Box, was driven by a keen understanding of a very
specific customer’s unmet needs. Why did he understand them so well?
Because he was the customer!

A Frustrated Computer Technician

and College Student
In 2002, Joel was a senior at Bellhaven College in Jackson, Mississippi,
working his way through school as a part-time IT support representative.
Given his need to balance work and school demands, he was frustrated by
the fact that he often spent twice as much time driving to meet clients as
he did fixing their computer problems.2 As a result, he began working on
28 BUSINESS MODEL DESIGN AND LEARNING

a system that would enable him to view and correct problems remotely
from his own desktop. “I hacked together a piece of technology I didn’t
really intend to sell,” he said. “It was really just to make my work easier.
But I figured I couldn’t be the only tech support person on the planet that
had these frustrations.”3
Shortly after graduation, he began promoting the software through an
html page he wrote for the purpose. In his first two months of business,
Bomgar sold 50 licenses at $500 dollars apiece,4 a sure sign of viability for
his fledgling business.
Less than a decade later, Bomgar’s appliance-based products help
organizations improve tech support efficiency and performance by
enabling them to securely support nearly any device or system, anywhere
in the world—including Windows, Mac, Linux, iOS, Android, and
more. More than 6,500 organizations across 65 countries have deployed
Bomgar to improve customer satisfaction while dramatically reducing
costs. The company reported $31 million in revenue in 2011, and had
approximately 200 employees working in 6 offices, including hubs in
London and Paris.5 At 32, Bomgar remains its CEO.
A good example of a satisfied Bomgar customer is Boston-based
Houghton Mifflin Harcourt Publishing (HMHP) Company, the world’s
largest publisher of educational materials for prekindergarten to high
schools. In addition to its traditional textbooks and testing materials, the
company sells educational software, including math and reading software
for students, as well as server software that allows school districts to build
portal sites. Overall, the publisher’s tech-support staff receives 100,000
calls a year, with over 40,000 of them ringing in from August through
mid-October, at the start of each new school year.6 Trying to deal with
this spike in demand each fall was an ongoing issue. In addition, 20% of
its calls were from Macintosh users and the product they were formerly
using only supported PCs.7
HMHP switched over to Bomgar in 2007 because it offered more
features and was less expensive.8 In addition to supporting Mac users,
the Bomgar Box also allowed HMHP’s employees to exchange instant
messages with customers, which was important because many teachers
don’t have phones in their classrooms or computer labs. Additionally,
the Bomgar system allows two technicians to log into the same session,
 HOW THE BOMGAR BOX DELIVERS CUSTOMER VALUE 29

which is helpful if one support representative needs a colleague to help

resolve a call. This feature also allows new tech-support trainees to log into
a session and watch experienced staffers troubleshoot.9 According to the
HMHP personnel, once the tech-support center implemented the Bomgar
remote-support tool, it saw an immediate return on investment, including
faster call resolution, more calls handled per worker, and lower costs.
Bomgar’s remote-administration tool has made the job faster and
easier for HMHP’s tech-support team who admit that they “couldn’t live
without it.”10 In the next section, I explore three ways that the Bomgar box
provides value to its customers: (a) By helping them achieve long-term
goals; (b) by solving a pressing problem; and (c) by adding benefits and
reducing costs.

A Hierarchy of Customer Value

Three decades of marketing research strongly suggests that perceived value
is based on assessing product costs and benefits in relation to goals and
objectives.11 We can see how this works using Woodruff ’s12 customer value
hierarchy, depicting three levels of customer goals and purposes (Figure 3.1).

Desired customer value

Customer’s
goals and
purposes

Desired
consequences in
use situations

Desired product
attributes and
attributive
preferences

Figure 3.1. The customer value hierarchy.

30 BUSINESS MODEL DESIGN AND LEARNING

According to Woodruff, customers think about value in a means–end

way.13 If we start at the top of the hierarchy, we can see that the custom-
ers’ long-term goals and purposes shape the desired consequences in use
or current job to be done. In turn, the thing that the customer is trying
to get done right now shapes his or her preferences for particular kinds of
product features.
If we start at the bottom of the hierarchy, we begin by observing that
customers think about products as bundles of specific attributes.  These
attributes are evaluated on the basis of their ability to facilitate the achieve-
ment of desired consequences, or jobs, at the middle level of the hierarchy.
These consequences are important because they allow customers to move
toward their long-term aspirations and purposes.
Applying these three levels of customer goals to the HMHP company
helps explain the high value the firm places on the Bomgar Box. The com-
pany’s long-term goals include growth and return on investment, and its
fundamental purpose is to help students learn. These economic and social
goals affect its desired consequences in use, or the problems that computer
technicians run into when trying to assist teachers from afar. With customers
all around the world, the tech-support team can do this much more quickly
and easily by using the Bomgar box to access the teachers’ computers. At the
lowest level, some particular attributes of interest include the product’s abil-
ity to connect with many types of computer hardware, its instant messaging
capability, and the ability to sign on multiple technicians at one time.
So, to understand whether a customer will perceive value in a particular
product or service, you must consider three things: (a) What are the cus-
tomer’s long-term goals and purposes? (b) What is the job that the customer
is trying to get done right now in light of these goals? (c) How does the
customer evaluate the costs and benefits of particular product attributes
in getting this job done? Let’s look at each of these drivers in more detail.

Helping Customers Achieve Long-Term Goals and Purposes

Huffman Ratneshwar, and Mick14 describe the highest level of customer

goals and purposes as life themes, or personal ideals of living, including
chosen life roles and identities. As we go through life, all of us develop
deeply held beliefs about certain ideals or certain end states of existence15
 HOW THE BOMGAR BOX DELIVERS CUSTOMER VALUE 31

such as freedom, education, or family unity. Similarly, we come to identify

ourselves within certain roles or identities, such as teacher, father, or
successful manager. These deeply held beliefs are reflected in our long-
term goals and commitments, both for ourselves and for our families or
communities. Research has shown that life themes are limited in num-
ber within an individual, and that, once established, they rarely change.16
Together with life roles, they represent core conceptions of self,17 and are
easily activated across a variety of circumstances.18 Moreover, once inter-
nalized, these aspirations serve as standards to guide many shorter-term
decisions and actions.19
As customers, our identities along with our long-term goals and val-
ues may affect our preferences for particular kinds of products or services,
or the way we evaluate the costs and benefits of particular product attrib-
utes. We may be more willing to pay extra for certain benefits that appeal
to our values, or we may be willing to sacrifice our time or money in order
to be part of something that we find meaningful.
Many companies have built successful business models based on their
understanding of their customers’ aspirations and self-identity. Dapple,
for instance, is a company formed by two mothers whose mission is to
create natural cleaning products for households with children. The com-
pany sells baby-safe products made from nontoxic ingredients found in
nature that are also proven to tackle unique baby cleaning challenges.20
The company was started by moms to appeal to moms. It aims at their
desire to be the best moms possible. It does this by also solving specific
problems.

Solving a Customer’s Problem

Johnson, Christensen, and Hagerman say that every customer value

proposition should begin by helping customers to get an important
job done.21 By job, they mean a “fundamental problem in a given
situation that needs a solution” (p. 52). They go on to say that once
we understand the job and all its dimensions, we can design the offer-
ing. In fact, the more important the job to the customer, the customer
satisfaction with current options for getting the job done, the more likely
it is that you will be able to produce real customer value.22
32 BUSINESS MODEL DESIGN AND LEARNING

In a popular You-Tube video, Harvard Business School’s Clay

Christensen talks about “milkshake marketing.”23 In his talk, he tells
a story about trying to help a fast food chain figure out what job cus-
tomers were trying to get done when, in his words, “they hired a milk-
shake” for breakfast.24 After observing and interviewing customers, they
learned the following:

“Most of them, it turned out, bought [the milkshake] to do a

similar job. They faced a long, boring commute and needed some-
thing to keep that extra hand busy and to make the commute
more interesting. They weren’t yet hungry, but knew that they’d be
hungry by 10 a.m.; they wanted to consume something now that
would stave off hunger until noon. And they faced constraints:
They were in a hurry, they were wearing work clothes, and they
had (at most) one free hand.” The milkshake was hired in lieu of
a bagel or doughnut because it was relatively tidy and appetite-
quenching, and because trying to suck a thick liquid through a
thin straw gave customers something to do with their boring com-
mute. Understanding the job to be done, the company could then
respond by creating a morning milkshake that was even thicker
(to last through a long commute) and more interesting (with
chunks of fruit) than its predecessor.”25

As Christensen’s milkshake story shows, the word “job” is used very

broadly to describe whatever it is that a customer is trying to accomplish
at a particular time whether it involves working or dining, or being enter-
tained or trying to take a nap. These needs may relate to hobbies, habits,
or professions.
According to Christopher et al.,26 to provide something of value to a
customer, you must always begin by indentifying what he or she is trying
to do with your firm’s offering at a particular time and place. Woodruff 27
calls this the customer’s use situation. Solving a problem for a customer
begins by trying to understand what he or she is trying to do, and what
is making it difficult.
Joel Bomgar solved a big problem for computer technicians who
were hindered in their ability to serve their distant clients. However,
 HOW THE BOMGAR BOX DELIVERS CUSTOMER VALUE 33

when asked directly why HPHM switched over to Bomgar’s products,

Robert Baird, manager of HMHP’s technical support center in Fort
Worth, Texas, said it was because Bomgar offered more features and was
less expensive than their prior solution. According to Woodruff’s hierar-
chy, the usage situation, or the job to be done, shapes customers’ prefer-
ences for particular attributes and desired attribute performance. The
next section talks about how customers find value in product attributes
and features.

Providing Benefits and Reducing Sacrifices

Multiple benefits and costs are considered by customers when determining
the use value of an item. In making this valuation, customers at least
implicitly compare perceived benefits against other noneconomic costs,
or sacrifices, such as the time, effort, psychic or physical energy required
to buy or utilize the product or service, and against the actual exchange
value required to pay for those benefits.28 Obviously, the greatest use-value
derives from offerings that are believed to yield the most benefits and
require the least expenditure of resources.
The use value of any product offering relates to its perceived per-
formance, as well as possible physical, social, or emotional outcomes,
which may be positive or negative depending on the customer.29 Physical
outcomes could include the possibility of getting hurt (a sacrifice)
versus the possibility of improving your health or physical attractive-
ness in some way (benefits). Social outcomes could be negative, if I am
concerned that the use of the product will make me look silly, or older;
they could be positive if they make me feel similar to someone I admire,
or if they lead to my involvement in a community. Emotional outcomes
could involve anger or frustration if the product is difficult to use or
does not meet my expectations. However, by using a product I may
feel happier or more confident. Indeed, I may feel that a product fits
into my lifestyle and improves my self-efficacy. I will speak more on
this level of outcomes soon. The important point in this discussion is
that through their use of a product, customers translate its features into
benefits and sacrifices. Based on those, they make their determinations
about whether or not to buy.
34 BUSINESS MODEL DESIGN AND LEARNING

Often these value calculations require trade-offs.30 For example, a

desired benefit may be reduced or sacrificed in return for larger amounts
of other benefits. Or some aspect of expended cost (time or effort) may be
traded off against price. In a slow economy, for instance, a consumer may
be willing to drive further in order to purchase a product for a reduced
price. The extent to which trade-offs are made can vary widely with
aspects of the current situation or one’s self identity or values. On the one
hand, a customer may be willing to accept fewer benefits when buying an
object for home use than he or she would if it was needed for the office.
On the other hand, a mother might expect more benefits from a product
she is buying for her baby versus one for herself.
Although I seem to be implying that the customers’ processes of weigh-
ing various costs and benefits, and even making trade-offs among them,
are quite rational and systematic, this is not always the case. Research
shows that these calculations are subjective and individual and vary
among consumers.31 Moreover, some evidence suggests that the weighing
of costs and benefits does not always take place consciously and consum-
ers may depend on cues to form impressions of value.32
Marketing researchers have long known that customers do not consider
all potential benefits equally.33 Some benefits may be more central to their
calculations because they relate to deeply held values, life themes, and
cultural or social goals. Also, a person might evaluate the same product
differently at different times. Price may be the most important considera-
tion at the time of purchase but a good manual may be more important
at the time of assembly.34 Evidence also suggests that more knowledge-
able consumers may gain greater value from particular product or service
attributes than others.35 Someone who knows every feature on his or her
smartphone will certainly enjoy it more than someone who barely knows
how to answer a call.
One way that customers assign value to your product is to evaluate
the benefits derived from using it versus the sacrifices. While there is no
set list of benefits and sacrifices, they can be physical, emotional, or social
and they may relate to the utility of the product or service itself, or to the
ease of accessing or maintaining it, the ease of learning how to use it, the
enjoyment it provides, or the friends that it helps them to make.
 HOW THE BOMGAR BOX DELIVERS CUSTOMER VALUE 35

If this seems complex, it is. And yet we do know that product

benefits and costs tend to be evaluated in light of a context. That is,
product features are more likely to be viewed as benefits if they help
the customer to get a job done right now, or if they help to achieve
long-term goals, or if they fit with our personal self-image and values.
HMHP Company’s tech support group loved Bomgar’s multiplatform
capability, its instant messaging, and its ability to sign on multiple
technicians because they could do their jobs better and faster than
before. It allowed them to do their jobs better, thereby helping the
company to succeed.

What Do You Value?

Although this chapter has focused on explaining how our customers

perceive value, I should point out that the same drivers of customer
perceived value also relate to you. As an entrepreneur or a manager,
you also enter the value exchange relationship in hopes of achieving
multiple levels of goals and objectives. Table 3.1 compares the three
levels of motivators or drivers for both firms and their customers.
Huffman Ratneshwar, and Mick suggest that the highest level of
goals relate to broad life themes and values associated with “Being;”
the middle level goals relate to “Doing,” and the lowest level relates
to “Having.”36 I mention this here because business models must be
designed to create value for both the customer and the firm. What
each party perceives as valuable is shaped by an array of aspirations and
considerations.

Table 3.1. Three Levels of Drivers for Firms and Customers

Firm or entrepreneur Customer
Being—What is our place Vision and values Aspirations and
in the world? Self-identity
Doing—What do we need Mission and strategy Current concerns or job to
to get done? be done
Having—What do we hope Economic and Social Benefits and Costs
to gain? Returns
36 BUSINESS MODEL DESIGN AND LEARNING

Designing Your Deliverables to Provide Customer Value

When you design your product or service offering for customers, it is

based on your best guess about how your customer defines value. Keep
in mind that it is not just your product or service itself that contributes
to this assessment. Your deliverables include the following: (a) the actual
product or service; (b) the price; (c) the customer’s ability to access it; and
(d) the actual purchase transaction or interaction.

• The product or service is the core of your offering. Obviously

it has to do what it says it is going to do. Functionality and
quality are two key issues here. Moreover, it has to do it
without causing harm to the customer; better yet if it can
make some experience more pleasant. Many other factors
go into customer evaluations of your product depending, of
course, on what it is. Suffice it to say that the actual mix of
features that you select will be evaluated and judged.
• The price of your product or service is important. Too high
and it will turn customers off, too low and your product may
be viewed as cheap. For services or online offerings, the way
you price is important. This is called your pricing mechanism.
Popular pricing mechanisms for online firms are freemiums,
pay walls, and pay-per-use mechanisms. Appendix A lists
many such mechanisms that can be considered when
developing your model.
• Access refers to whatever your customers have to do to get or
use your product. Can they get it at Walmart? Can they get
it online? Do they have to drive to the next town? Do they
have to wait for an appointment? Do they have to wait until
it comes to their town? There are often obstacles that make it
difficult for a customer to access your product or service. If
you can make it easier, you are reducing a sacrifice. However,
sometimes, limited access can be a sort of benefit if it provides
some status to those who get it first.
The Internet has opened the door to many new businesses by
providing a simple, inexpensive means of providing customers
 HOW THE BOMGAR BOX DELIVERS CUSTOMER VALUE 37

with access to your products and services. Consider the explosion

in sales of self-published books on Amazon today. Check out the
many different handmade products available for sale on Etsy.
com. Appendix B provides you with a list of online marketplaces
that can be very useful in reaching out to your customers.
• Transactions and interactions. A transactional encounter is
one that is purely focused on the task, say checking out a
customer in a convenience store, or delivering a pizza. If
the service provider is simply going through the motions to
carry out the purchase, then it is a simple transaction. An
interaction, by contrast, occurs when the participants are
actually communicating, and forming a relationship. Any
transaction also has the potential to become an interaction if
the service provider cares about making it happen and takes
an interest in what the customers have to say. Customers
will often return to particular shops or stores because they
enjoy the relationship with the clerk or beautician, or advisor.
Interactions can be very important contributors to customers’
perceptions of value.

Summary and Conclusions

Let’s return briefly to the story of Joel Bomgar that opened this chapter.
Joel Bomgar was a computer technician trying to work and go to col-
lege. He was strapped for money and time and he was tired of wasting
so much time driving to his customer’s offices to fix relatively sim-
ple problems. Joel never intended to start his own business; he simply
wanted to find a way to do his own job more effectively. His busi-
ness model made sense because he completely understood the situ-
ational demands faced by many computer technicians and he was able
to design a product to solve a frustrating problem and help them to do
their jobs better.
In addition, Bomgar knew how to instill his offering with attributes
that customers perceived to be valuable. His initial decision to put
the software in a box versus on the cloud was an example of a feature
that appealed to his users. Its pricing had options for different sizes of
38 BUSINESS MODEL DESIGN AND LEARNING

business. His website is full of information and forums for discussion

and ongoing learning, all of which are beneficial to the professionals who
use his products.
The next chapter begins with the story of another business founder
who also had an intuitive understanding of his customer. I show how this
business leader took this understanding and built it into a highly effec-
tive venture using the foundation and differentiated business model lenses
described in Chapter 2.
 CHAPTER 4

A Ham Radio Company

Builds a Superior Business
Model
Martin Jue is a soft-spoken man with large passions. Right now, he is
passionate about business models. To him, it is obvious what you have
to do to make a business work. You have to sell something he says. That’s
the main thing.
Martin is the founder of MFJ Enterprises, a leader in the ham radio
industry. Today, it is estimated that there are over 600,000 ham radio opera-
tors in the United States and over 2 million worldwide. Ham radio operators
are a close-knit community, attending hamfests, which are both tradeshows
and social gatherings, communicating with each other over the air waves,
and listening. Martin’s ham number is K5FLU. In this eccentric industry,
this Asian-looking man with the Mississippi Delta accent is a star.
In fact, Martin’s company, MFJ Enterprises, has just celebrated its
40th anniversary. It hosted a huge picnic for the event, with door prizes,
factory tours, tailgating, free forums/discussions, and FCC license exams.
Hundreds of people attended, from local officials and university students,
to visiting industry leaders from the American Radio Relay League, Ham
Nation, and other groups from all over the country. One major guest was
Chip Margelli, the marketing director at CQ Magazine who once chal-
lenged world champion text messengers to a race on the Jay Leno show to
see whether cellular text messaging or radio-based Morse code could send
messages faster. “By using Morse code, he beat those guys by far,” Jue said.1
When I asked Martin why MFJ’s business model was so successful,
he laughed and said it was the best kind of business model—the cheap
kind. To me, his description is overly simplistic. Yes, his company is
notoriously cheap with regard to its facilities, offices, and so forth. But
40 BUSINESS MODEL DESIGN AND LEARNING

it also sells more pieces of ham radio equipment than anyone else in the
business. That MFJ leads the industry on innovation is directly due to
Martin’s personal capabilities as an electrical engineer, and his love of ham
radio. He built his first radio at 8 years of age. He had a ham radio license
at age 16.
I will use Martin’s company as an example as I discuss the five ele-
ments comprising the foundation and differentiated business model
lenses. Although I discuss the elements in a particular order, an order that
helps me to tell Martin’s story, I want to emphasize that you can think
about these components in any order, depending on how they relate to
your initial idea, and which ones stimulate your thinking right now. The
purpose of using a model like this is to help you bring the different aspects
of your thinking together and to create a logic for doing things that makes
sense both to you and to your customers.

Thinking Through MFJ’s Business Model

Foundation
Figure 4.1 depicts MFJ’s foundation business model. As you can see,
it includes four elements—Key Resources, Key Processes, the Profit

• Everything done through in-house

manufacturing
• Nationwide dealer network
• Attending tradeshows

Key
processes
1

• Talented product • Broad array of

Key Martin Jue’s Value quality amateur radio
designers aspirations
resources proposition products for HAMS
• Cheap facilities and goals

Profit
formula • Cash flow
• Keeping cost of sales low
• Low overhead
• All about making money • Everything they do is to
• Design skills make money

Figure 4.1. MFJ foundation business model.

 A HAM RADIO COMPANY BUILDS A SUPERIOR BUSINESS MODEL 41

Formula, and the Customer Value Proposition2 plus the firm leadership
in the center.
Firm aspirations and goals drive all business modeling decisions.
For start-ups, these derive from the entrepreneur and the management
team based on their vision and values, experience, and capabilities.
As a leader, your vision, long-term goals, and values help determine
the kind of market you are interested in serving and whether you are
seeking high growth or stable income. In an income-driven model, the
entrepreneur will invest to the point that the business can generate
an ongoing and stable income for the principals. In a growth model,
investment and reinvestment are sought in an attempt to grow the
value of the firm to the point that it will generate capital gains for
investors.3
When Martin was young, his family ran a grocery store in the
Mississippi Delta. He always knew that he was going to run a busi-
ness. In fact, he believes very strongly that the whole purpose of a
business is to make money. He says that he has one conversation,
frequently, with managers and employees at every level of his com-
pany. It goes like this. Make sure whatever we do makes money. The
first question we should ask is, is this going to make us money? Job
security happens when we are making money. In other words, Martin
was always interested in generating income. He also preferred to own
the business himself.
Another leadership attribute that can influence basic business model
choices relates to deeply held values. Sometimes your values will stop
you from doing certain things, even if those things would be profitable.
Other times your values will take you in positive directions. As the child
of Chinese immigrants, Martin was always very sensitive to diversity
issues and this concern has been reflected in his hiring decisions from
the beginning. He brags that his company includes people from all over
the world, a factor that surely has contributed to his ability to bring
talented engineers and designers to a small southern town. Finally, on a
simpler level, the entrepreneur’s particular skills and capabilities have a
strong influence on how a business model can work. As the next section
shows, Martin’s electrical engineering skills have certainly played a role
in his business.
42 BUSINESS MODEL DESIGN AND LEARNING

Key Resources could include people, technology (inventions,

patents), products, facilities, equipment, and even things such as estab-
lished brands, which you can use to create something of value for a cus-
tomer. These resources may be owned, purchased, or acquired through
partnerships.
Although MFJ employs several talented product designers, the major
resource related to the company’s innovation ability is Martin himself.
With his engineering background, he knows how to design products,
and, as a ham radio lover, he has an intuitive idea about what to design.
He also maintains frequent contact with customers, through attending
conferences and giving speeches. He listens to his customers and responds
with offerings.
Key Processes include the capabilities needed to make and sell your
product.4 These may include recurrent tasks such as training, research and
development, manufacturing, budgeting, planning, sales, marketing, and
service. Again, these may be carried out internally or outsourced to part-
ners. Key processes also include a company’s rules, metrics, and norms.5
One very important key process at MFJ is its approach to manufac-
turing. The company strives to make everything it can make by itself in
order to keep costs low. The firm is fully vertically integrated with all the
appropriate machines and equipment.
In addition, the company sells its products through a nationwide
network of dealers, as well as an online catalog. Martin and his team also
attend ham fests and trade shows to promote their products and meet
with customers.
The Profit Formula, according to Johnson, Christensen, and Hagerman,6
is the blueprint that defines how your company will create value for itself.
Understanding your revenue flows is the first step of building this blue
print. After that, it is essential to keep a close eye on your profit margins,
overhead, breakeven volume, and resource velocity.
Martin understands the importance of cash flow and, particularly, the
importance of keeping the cost of sales down. The biggest problem many
companies have is that their cost of sales is way too high, he says. This
kills everybody.
He keeps his overhead low by operating out of old metal build-
ings. As an engineer who finds beauty in an electrical circuit, he has
 A HAM RADIO COMPANY BUILDS A SUPERIOR BUSINESS MODEL 43

little appreciation of aesthetics. He runs his life the same way. He will
occasionally buy his wife a new Lexus, but he takes the old one.
Customer Value Proposition. Value propositions explain how your
product or service provides value to the customer. Value may be built into
actual product or service features, into the channel or delivery system, the
brand, and even the pricing mechanism. You can think of it as a package
of deliverables. Taken together, these elements lay the groundwork for the
total customer experience.
MFJ’s value proposition is to provide customers with a broad array
of quality ham radio products, which are sold all over the world by a
network of over 200 dealers, and an online catalog. Here is what the
company has to say on its website:7

• MFJ’s slogan, “Making Quality Affordable,” has been well

received in the ham radio community. The niche of the market
was captured by offering quality accessory products at low prices.
• Constantly changing and constantly improving, MFJ and its
subsidiaries have managed to stay on top of their share of the
market by a generous customer service policy and listening to
what the customer wants.
• MFJ offers a one year unconditional warranty called the
“NO MATTER WHAT” warranty. MFJ will replace or
repair a customer’s MFJ unit (at MFJ’s option) for one
complete year. A technical help support line is also offered
toll-free for customers needing help or advice with a ham
radio project.

Evaluating the Business Model

Foundation—Feasibility and Viability
So far, I have described the logic behind MFJ’s basic business model.
I pointed out earlier that, in a start-up, this model begins as a hypothesis
that must be tested. The first two tests are to determine whether the idea
is feasible and whether it is viable.
When someone asks if your business model is feasible, they want to
know if it can actually be done.8 Is it realistic? Is the technology available
44 BUSINESS MODEL DESIGN AND LEARNING

to consistently deliver the promised benefits to consumers?9 There are

many factors that can make a business model unfeasible. Let’s consider
resources, for instance. Recently, I worked with a group of people who
were interested in setting up a wood pellet plant in a small town where
land was cheap and the supply of wood was bountiful. In this case, feasi-
bility was problematic because there was no access to rail or water trans-
portation to move the product cheaply to a port.
For Martin Jue, feasibility was not a problem. He had been building
electrical circuitry since he was 16 years old. His first product was a
high selectivity filter that would enable a receiver to separate one Morse
code signal from scores of other signals that were being transmitted over
the radio airwaves. He designed it himself using a new technology that
allowed him to build it so cheaply that no one else could do it. Then he
ran a 2 × 2 advertisement in the now-defunct Ham Radio Magazine
(it was full of engineering, technical jargon, he said.). He sold 5,000 in a
couple of years, proving the feasibility of the business, but, certainly, this
was not enough volume to live on.
A model is viable if you can show that there are enough customers
out there willing to buy our product at a price that covers expected
costs and generates a profit10 For someone like Martin, who is inter-
ested in generating an income, the actual question is: can you make
a living doing it? Answering this question requires a real understand-
ing of who the customers will be and how they will get access to the
product. It also requires having a good idea about appropriate price
points and cost structures. In fact, it makes sense to say that the whole
point of working out your business model is to ensure that your idea
will be viable.
The likelihood that your product will be viable is greatly enhanced by
being passionate about the industry you are entering. If you are part of
it, then you get what the customers want. And you know how to talk to
them. Based on the experience with his first product, Martin learned that
his customers really wanted something “they could just use…something
in boxes.” So he got the boxes at Radio Shack and took it up a notch. This
time he got a toll-free Watts line and added a couple more products. He
ran a full page ad in QST magazine and he sold more in one month than
he had in the previous year.
 A HAM RADIO COMPANY BUILDS A SUPERIOR BUSINESS MODEL 45

This experiment addressed the viability question. Now he had an

understanding of the size of the market, what customers wanted, and how to
get access to them. His business model appeared to be viable.
In their book, Blank and Dorf say that the goal of business modeling is
to find a repeatable, scalable model.11 Moreover, the primary value of a start-
up is to validate its business model hypothesis. To be feasible, a model has
to work; that is, you have to show that you can craft an offering that does
what it is supposed to do when customers use it. To be viable, you have to
show that customers will actually buy it. As Martin Jue says, the key is selling
something. Or to put it another way, the key is having enough customers
who are willing to buy that you can cover your costs and earn a profit.

MFJ’s Business Model Differentiators

Feasibility and viability are important to building a business model
and getting your new company off the ground. However, additional
considerations must be made to ensure that the model will be sustainable
over time. Key among these is finding ways to differentiate the firm from
competitors and provide superior value to customers. Figure 4.2 shows
MFJ’s differentiators.
The key factors separating MFJ from other competitors include both
Martin’s ability to lead the development of innovative new products and,
at the same time, to keep costs low. MFJ’s innovation capabilities stem

Key
processes
2 1

• Jue’s design skills Firm • More new products than

generate new Key Value ANY other competitor
aspirations
products at low resources proposition • Low prices and excellent
& goals
costs customer support

Profit
formula

Figure 4.2. M.F.J’s differentiated business model.

46 BUSINESS MODEL DESIGN AND LEARNING

from several factors, including Martin’s personal interest in the hobby, his
connection with his customers, and his electrical engineering skills.
As I pointed out earlier, Martin has been a ham radio fan since he was
a child. If you look in his back yard, he has wires draped across his deck
and tacked to his house. If you visit his office, you can see his collection
of radios that has been accumulating for years. He gets it. In addition,
he and his team of managers like to go to hamfests. They travel from
Mississippi to events as far away as New Hampshire, Texas, Florida, and
Oregon. The hamfests allow MFJ leaders to meet customers in their
local arenas and to keep in touch with their needs.
Another way that Martin keeps in touch with his customers is
through the company website. Although the website is very technical,
it is designed to appeal to the serious amateur radio operator. Martin
personally writes the descriptions of many different products, and he
carefully hones his words to reach out to his customers. He wants them
to read each description and say only one thing—I’ll buy that. Customers
can also post reviews of each product. More recently, a Facebook page has
been created and conversations occur there as well.
Martin’s personality and background are also instrumental in his
passion for keeping costs low. He is fanatical about cutting out excess costs
by building everything possible in-house. And, as I mentioned earlier, the
facilities are certainly bare bones. When you combine these capabilities,
you can see why MFJ actually provides better value than competitors do.
The company’s value proposition is based on offering superior value to ham
radio operators by offering the broadest array of products on the market, at
great prices, and with excellent support by a firm that understands hams.
As Martin says, the company designs and sells more new products
continually than anyone else in the business. The MFJ value proposition
is part of a complex business model that is both low cost and differenti-
ated, based on its continual innovation and introduction of new products
and its low-cost operating style.

A Note on Integrated Business Models

As I’ve already mentioned, MFJ uses a vertically integrated model. As

mentioned in Chapter 2, this was once the dominant form of business
 A HAM RADIO COMPANY BUILDS A SUPERIOR BUSINESS MODEL 47

model among manufacturers. However, over the past half century, many
industries have undergone fundamental changes and a breaking up of
these integrated business models has occurred.12
In recent years, many integrated business models have been split into
smaller and smaller segments as new specialized businesses have been
created. As a result, vertically integrated companies like MFJ now face
speedy new competitors who specialize in just one step of the value chain
(and do it better or cheaper). Another new breed of competitor is one
who orchestrates a whole network of suppliers in creating a customer
offering. Each supplier contributes a different step to the final product.
These kinds of changes are not only creating new businesses and new
markets, but also causing formerly separate industries to converge. Con-
sider mobile phones, computers, and televisions. Changes in technology,
government deregulation, and managerial creativity are all accelerating this
trend.13 These kinds of changes are also making it easier for new entrepre-
neurs to start their companies. You don’t have to do your own manufactur-
ing any more. Just find a partner. Or find several partners.

What About the Future?

The integrated business model configuration has worked very well for
MFJ. For this company, vertical integration has helped keep costs low and
speed products to market. In fact, MFJ’s business model has sustained the
firm for 40 years. This is clearly a success story for Martin and his team.
Looking forward from here, however, leads to some difficult questions.
The big one is this—What might happen to the firm without Martin? He
is the key to MFJ’s differentiation and competitive advantage in the mar-
ket place. Without his influence, the entire model might come apart at the
seams. Martin believes that it would take several different people to replace
his unique position within the firm. This is the next issue that he will have
to confront to sustain his company for the longer term.

Summary and Conclusions

In this chapter, I used the foundation and differentiated business model
lenses to show how a company can create superior value for its customers
48 BUSINESS MODEL DESIGN AND LEARNING

through good business model design and hard work. Like Joel Bomgar,
Martin Jue was able to put this model together because he had an
intuitive understanding of his customers and their needs. Also like Joel,
Martin was an engineer who could bring his product ideas to life. But
with Martin, we saw one more thing, and that was his clear focus on
building a business that would make money and provide him and his
family, and his employees, with a good life. He never lost this focus. In
fact, even today, he preaches this lesson to young entrepreneurs whenever
he gets the chance.
The next chapter looks at a very different business model based on a
very different way of providing value. The company is called TOMS and
the founder is Blake Mykoskie.
 CHAPTER 5

TOMS Shoes
Selling a Vision

As we saw in Chapters 3 and 4, planning your business model should

begin with an in-depth understanding of your customers and their current
concerns. As Johnson, Christensen, and Kagleman note, “it all starts with
thinking about the opportunity to satisfy a real customer who needs a job
done.”1 Both Joel Bomgar and Martin Jue knew their customers very well.
But what happens when your business idea is based on something
else? Like the belief that you can make the world a better place. The ques-
tion to be addressed in this chapter is: Can you build a successful business
model around selling a vision? And if so, how do you ensure that your
customers will continue to be part of the vision?

TOMS Shoes
I first heard about TOMS Shoes’ founder, Blake Mycoskie, when he gave
a talk at my university in 2010. The students turned out in droves to hear
him. This was a surprise to me because I had been working hard to bring
speakers to campus that would resonate with the student body. We brought
in famous generals, nationally known political pundits, and cable television
news experts, but never did we get the response that Blake Mykoskie got.
Since its founding in 2006, this company has grown quickly into a
phenomenon. By 2012, it had sold over 2 million pairs of shoes and
given away an equal amount using Mykoskie’s “buy-one give-one business
model.”2 With this model, TOMS appears to be the perfect exemplar of a
vision-driven business, or one that is striving to produce a positive effect
on the world. The first interesting thing to think about in this story is how
Blake came to put this idea together.
50 BUSINESS MODEL DESIGN AND LEARNING

Blake Mycoskie was 29 years old when he started his business. Before
TOMS, Blake, a native of Texas, had already started five businesses. His
first was a successful campus laundry service, which he later sold. Between
business ventures, Blake competed in the CBS primetime series, The
Amazing Race. With his sister, Paige, Blake traveled the world and came
within minutes of winning the $1 million grand prize. This experience in
putting together companies, as well as the publicity he got from being in
a T.V. show were both important in explaining his ability to put such a
successful start-up together so quickly.
A couple of years after The Amazing Race, Blake visited Argentina
again, for a vacation. While exploring the country, two things happened.
First, he met an American woman who was volunteering with an organi-
zation that collected shoes from donors and gave them to kids in need. She
told him that many kids lacked shoes, even in relatively well-developed
countries such as Argentina, an absence that complicated their attempts
to go to school, and also exposed them to a wide range of diseases.3 What
interested Blake, in addition to the idea of delivering shoes to kids, was
the fact that the efforts were currently hampered by lack of control over
the supply of shoes to deliver. The organization relied on donations that
were hit or miss, in terms of timing, size, and amounts.
The second thing that happened was Blake’s discovery of a traditional
Peruvian shoe called the alpargata, a soft casual shoe worn all around the
country.4 He thought that the style and feel of the shoe might go over well
in the United States. Thus, he came up with his new business idea:

“Why not create a for-profit business to help provide shoes for

these children? Why not come up with a solution that guaranteed
a constant flow of shoes, not just whenever kind people were able
to make a donation? In other words, maybe the solution was in
entrepreneurship, not charity.”5

And so the idea was born to create a business model that revolved around
making a new kind of alpargata to sell in the Unitd States, and, for every pair
sold, to give a pair to a child.6 It took some research, but eventually Mycoskie
found a Peruvian shoe maker to put together a couple hundred pairs of his
new design. The shoes were named TOMS—shoes for tomorrow.
 TOMS SHOES 51

After flying back to California, with a duffle bag full of shoes, he talked
to friends about how to sell them, and identified a top Los Angeles clothing
store, American Rag, to sell his shoes. The owner loved the story as well as the
shoes, and it wasn’t long before a fashion writer for the Los Angeles Times heard
the story and loved it too. On the day that her article appeared, the TOMS’
website had received 2,200 orders. Since there were only 160 pairs of
shoes remaining in the duffle bag, Blake hired three student interns who called
everyone on the list and told them they would have to wait for a while until
the shoes could be made (he lost one order). Then he raced back to Argentina
and to figure out how to manufacture more. It was about then that Vogue ran
a big story, and stories began popping up everywhere. He sold 10,000 pairs
working out of his apartment that first summer. The rest is history.
The next section describes some of the logic behind the design of
TOMS’ differentiated business model. The interesting thing here is that
TOMS did not start out as a basic shoe company. In fact, it was never a
basic shoe company. From the first moment, it has always been a com-
pany that gives a pair of shoes to a child for every pair of shoes sold. In
other words, this is a case where the business model was differentiated
right from the start. There is no real reason to consider the foundation
separately from the differentiators. They were built simultaneously in
support of the buy-one-give-one idea. Thus, we can begin with the dif-
ferentiated business model lens shown in Figure 5.1.
Key Resources and Processes. To get his company up and going
quickly, Blake drew on his personal network of friends and acquaintances
to raise money and to find outlets for selling his shoes. He sold the business
he was currently running (online driver education instruction) to his part-
ners and then invested a half million dollars of his own money into his new
venture. As sales grew, his ability to form partnerships remained an impor-
tant means of carrying out the firm’s operations in a low-cost way. For
instance, the company delivers its shoes through partnerships with chari-
table and religious organizations in the countries of choice. Volunteers can
also sign up to participate in the shoe drops on the company’s website.
A major part of the business model is that the company does not have
a marketing budget. It buys no advertising, relying on word of mouth, viral
marketing, and social media. Obviously, Mycoskie has excelled at getting
free publicity for TOMS by telling its story in many different venues,
52 BUSINESS MODEL DESIGN AND LEARNING

• No advertising budget
• Manufacturing in three countries
• Partner non profits deliver shoes

Key
processes
2 1

• Network of friends • Trendy, cute shoes

Key Blake’s Value
and partners • Customers feel good
resources aspirations proposition
• Volunteers & goals for helping others
• Free publicity

Profit
formula • Purchase price covers two
pairs of shoes
• Low cost of manufacturing
• Four prior startups • Inexpensive materials
• “Amazing Race” fame
• Vision of helping children
• $500,000 cash

Figure 5.1. TOMS’ differentiated business model.

giving speeches, attending conferences, and appearing online. In addition

to the stories mentioned earlier, the company has been written up in many
magazines and newspapers, and there are stories and videos all over the web.
Celebrities are often seen wearing TOMS shoes or wearing no shoes on the
annual “Day without Shoes” campaign.7 Clearly, people love this story.
The company headquarters is still in California where about 90 people
are employed. Manufacturing is outsourced to facilities in Argentina,
Ethiopia, and China, another decision that helps to keep costs low. Accord-
ing to TOMS’ website, the company requires its factories to operate under
sound labor conditions, pay fair wages, and follow the International Labor
Standards set by the International Labor Organization. Also, according to
its website, it strives to manufacture at least some shoes in the countries in
which it gives shoes.8
Profit Margin Considerations. Since its inception in 2006, TOMS has
given away over two million pairs of shoes to children in 40 developing
countries. The company’s canvas slip-on shoes—the same type it often
donates—now sell for $45 to $135 a pair in over 500 different retailers
ranging from Nordstrom and Neiman Marcus to independent shoe stores.
 TOMS SHOES 53

TOMS profit formula is based on the premise that the purchase

price actually covers two pairs of shoes, one for the customer and
one for a child in need. Also, as this discussion has shown so far, the
company keeps its costs in check by using volunteers and partners as
well as receiving a great deal of free advertising. In addition, the shoes
are made of inexpensive materials. Although the costs are not made
public, one estimate suggests that you could make the basic canvas
shoes (which retail at about $50.00 a pair) for somewhere between
$5 and $9 and that the smaller child’s pairs that are given away for
even less.9 This lends some credence to the idea that the firm is quite
profitable.
Customer Value Proposition. The real force behind TOMS business
model, however, is that when customers buy TOMS shoes, they get both
the trendy shoes and the story. They are buying an opportunity to feel
that they are doing good through their purchase. In the short run, this
value proposition has been so successful that the company has added
several other products to its lineup and it has inspired other entrepreneurs
to try similar business models. Mycoskie also states that he chose the
publisher for his book based on its willingness to agree to a buy-one-book
give-one-book arrangement.10
With regard to the shoes themselves, reactions vary. On the cost side,
TOMS shoes are not particularly beautiful; they are made from canvas
and plastic, and they have little arch support. They are also pricy. On the
benefit side, TOMS shoes are very trendy and recognizable, they come
in a variety of bright colors, and they are easily accessible at many stores
and online.
The TOMS’ business model shows that we do not just buy things to
resolve our immediate problems. We will also buy things that we believe
will make the world a better place, or that might make ourselves a lit-
tle better person. According to the Cone Cause Evolution study, 80 per-
cent of Americans are likely to switch brands, if comparable in price
and quality, to one that supports a social cause.11 It seems that many
customers find value in purchasing products or services that are associated
with causes they believe in.
Firm Leadership and Logic. Blake Mycoskie was not initially driven
by a vision to bring shoes to poor children across the world. He was an
54 BUSINESS MODEL DESIGN AND LEARNING

entrepreneur who had started five businesses, and he stumbled upon this
idea during his travels to South America. Although he has attributed his
desire to help others to the fact that his dad is a doctor and his mom wrote
a cookbook based on healthy recipes, he was not out there looking for a
way to help children. Rather, he stumbled upon the idea. And from there,
he built it into his business model.
David Teece suggests that business model pioneers often possess—or
develop—an understanding of some deep truth about the fundamental
needs of consumers and how competitors are not satisfying those
needs.12 It was certainly easy to see why Joel Bomgar understood the
frustrations of computer technicians and Martin Jue understood amateur
radio operators. It is more difficult to understand how Blake Mycoskie
knew that customers would be excited about paying a higher price to
purchase their own shoes in order to give shoes to children. Obviously, his
hypothesis was spot on. And, in addition, he had the know-how to build
an organization that could satisfy that need.
Clearly, not everyone could have implemented the buy-one give-one
business model with as much success as Blake Mycoskie. He already knew
how to build a profitable business and he had a half million dollars of
his own to invest, so he didn’t have to raise a lot of cash. Also, consider
the publicity he gained in his stint on the popular television show, The
Amazing Race. He was not only able to take advantage of his celebrity
status but also easily able to contact other well-known people. He was
quickly noticed by the press that was keen to tell his story and pro-
vided him with a wealth of free publicity. And, his shoe sales took off
immediately, showing him the power of the vision he was selling. His
biggest challenge was to scale the business up quickly enough to avoid
losing momentum.
Like Joel Bomgar and Martin Jue, Blake was and is a key part of the
business model. Even today, he calls himself “chief shoe giver” instead of
“chief executive officer.”13

The Toms Model Is an Orchestrator Model

Although most people focus on the buy-one-give-one aspect of the
TOMS’ business model, I would describe that facet of the model as a key
 TOMS SHOES 55

differentiator. The underlying configuration of the TOMS model is best

captured by the term “Orchestrator Model” since the company coordi-
nates activities in a network of suppliers.14 Orchestrators focus on one or
a few core steps of the value chain, while outsourcing and coordinating
the others.15 Competitive advantage is derived from superior coordina-
tion capabilities that give them access to all needed assets and access to
the entire value chain.16
Interestingly, Nike, the famous athletic shoe company, is another
highly successful orchestrator business in the shoe industry, founded by
the 26-year-old Phil Knight in the late 1960s. Nike’s success has been
based not only on the quality of its shoes, but also on its highly popu-
lar advertisements and endorsements of well-known athletes beginning
with Michael Jordan. It has built a cult-like following over the years by
understanding how to turn shoes into a status symbol. Like TOMS, most
of Nike’s shoes are manufactured in Asia. Unfortunately, the company
has been criticized many times for using independent contractors who
mistreat workers and pay them poorly.
TOMS has also been criticized for manufacturing in China but not
because of poor conditions in its suppliers’ manufacturing facilities. In
fact, as noted earlier, the company is careful to discuss, on its website,
these conditions and the steps that it takes to protect workers. The real
case against TOMS is that its business model may do more harm than
good in the countries it is supposedly trying to help. The argument is
that by bringing free shoes to children in poor countries, there will be less
opportunity for shoe manufacturers there to make a living and there will
be increased dependence on foreign kindness.17 If these complaints get
louder or more frequent, some buyers may change their minds about the
value of their purchase. To sustain itself in the long run, the company may
have to begin assisting communities with manufacturing their own shoes.
As a recent Forbes article pointed out:

“Toms could actually strengthen their business model by moving

away from charity and toward scalable manufacturing and
production practices that better monetize Toms by pulling former
‘charity cases’ into an actual productive economic relationship
with Toms and with one another.”18
56 BUSINESS MODEL DESIGN AND LEARNING

The debate is still on as to whether TOMS is doing good in the world.

To sustain sales over the long term, the company not only has to convince
customers that its actions are positive, but also has to ensure that they
are. Nike, for instance, has a social responsibility division with over 150
people in it and it is still being criticized for conditions in its Indonesian
supplier firms. 19 To be successful as a global orchestrator, the company
must pay careful attention to the selection of suppliers and practice
effective governance.

Sustainability Concerns and Responses

Criticisms of its international shoe drop approach are not the only threats
to TOMS’ sustainability. Here at home, TOMS is vulnerable both to
competitors in the shoe business and to those nonprofit and charitable
organizations promising to do good things.
On the shoe side, Sketchers has already made a direct run at TOMS
with a line of simple canvas shoes named BOBS. They look a lot like
TOMS shoes. In fact, Sketchers even promises to donate a pair to a child
in need whenever a pair is bought.20 However, the Sketchers shoes are so
similar, and the promise so clearly copied, that customer reactions have
been minimal.
Yet, shoes are fashion items and trends change quickly. Moreover, there
are hundreds of shoe companies out there with wide variations in design
and quality. To stay in tune with consumer tastes, the company will have
to innovate constantly. In addition to its basic canvas slip-on, the com-
pany is now offering the bota (ankle boot) and cordones (sneaker with
laces) for both sexes. Recently, it has increased its shoe lines to include
new VEGAN TOMS (made of 70% of plastic recycled bottles and 30%
hemp…) as well as wedding TOMS for those who prefer a casual option
in that setting. The company is also making some shoes from pesticide-free
cotton canvas, and using recycled rubber scraps in the soles. All of these
innovations indicate that the company is aware that selling shoes, actual
shoes, is critical for the buy-one give-one model to be sustainable in the
long haul. And to sell shoes, the firm will have to make sure they stay
trendy and stylish and that they provide the benefits that people are look-
ing for when they buy shoes.
 TOMS SHOES 57

On the feel-good side, the big question is: Will customers get bored
with giving shoes? What is to stop them from moving to the next oppor-
tunity to feel good about themselves?
To sustain interest, the company is continually innovating in terms
of the way it does good. Although the company still mainly gives the
canvas shoe to children, it has developed shoes with thick rubber soles for
those who live in monsoon areas as well as orthopedic boots for Ethiopian
children who suffer from a disease called elephant foot.21 In addition to
adding more products such as TOMS’ tee shirts to the buy-one-give-
one offer, it is also experimenting with new ways of helping people. For
instance, when you buy a pair of TOMS’ eyeglasses, a child in Nepal or
Cambodia or Tibet may get a pair of glasses, or may receive eye surgery
to correct the problem.
All of these moves are designed to connect to the customer and
differentiate the TOMS brand from competition. If TOMS can main-
tain its status as the exemplar in the buy-one-give-one category, then
it may be able to hold on to its following. To do so, it will have to
continue to innovate, but must also strive to be authentic. According
to Aakers:

“The authentic brand is perceived to be real rather than phony, a

brand that will deliver the category or subcategory quality, a leader
rather than a copier, one that took risks to create the defining
innovation, and reliable and trustworthy.”22

Authenticity requires making difficult decisions and doing the

right thing. However, just like the product attributes described earlier,
authenticity is determined by the customers. In the end, they are the ones
making the determination.

Building Customer Relationships

The ultimate key to TOMS’ sustainability will be whether it can con-
tinue to convince its customers that they are part of a worthwhile
movement, and that through their purchases, they will be part of
something that is good for the world. To think more clearly about
58 BUSINESS MODEL DESIGN AND LEARNING

involving their customer base, Mycoskie and his leadership team

should include their customer base as a part of the resources and find
novel ways to include them in rebuilding their brand and their actual
activities for the future. Figure 5.2 looks at TOMS through the adap-
tive business model lens, which includes the customers as part of the
business model.
Figure 5.2 lists some of the questions that TOMS’ leadership should
consider in order to sustain or renew the model in the future. As the
next paragraphs show, the company is engaging in some key activities
that are aimed at building and nurturing its customer relationships and
incorporating customers in its vision.
For instance, TOMS is doing several things that would seem to be
aimed at building a sense of community with its customers.23 Social
media is heavily used to provide a link to customers. Each pair of TOMS
shoes now comes with a blue and white flag card. Customers can take
their pictures wearing the shoes and upload them to the “THIS IS HOW
WE WEAR THEM” campaign featured on the company’s website, plus
Facebook and Twitter. In addition, Style your Sole parties are available to

• How can we facilitate customer

to customer communication
and learning?

Key
processes • What long term goals and
2 1 concerns are driving our
customers? Can we
assist?
• What current concerns or
Firm Customer
Key Value costs do our customers
aspirations aspirations
resources proposition & goals still face even when using
& goals
our product?
• What new alternatives or
substitutes are selected by
customers when they
Profit leave us?
formula

• Does giving away shoes provide the

best value to the children and
countries we serve?
• Are there other options to consider?
• How can we learn from our customers?

Figure 5.2. TOMS’ adaptive business model.

 TOMS SHOES 59

groups. You paint blank white shoes (and you get a 10% discount if you
buy more than 25 pairs).
More importantly, perhaps, are activities aimed at involving the
customers in TOMS’ philanthropic efforts.24 For instance, the company
sponsors a variety of activities for college students and others.

• TOMS campus clubs—service clubs are formed at high schools

and colleges with a mission of helping children in need.
• TOMS hires interns (called Agents of Change and Vagabonds)
to take on projects and promote the shoes. The company looks
for people who truly believe in what TOMS stands for.
• Campus groups can get a DVD about TOMS and use it to
facilitate discussions about the company’s activities and other
opportunities to get involved.

While these steps are clearly moving in the right direction, I would
argue that the next step should involve TOMS’ staff in listening and
learning from these discussions with customers. Finding the right ways
to help the world is not easy. The more voices you can get into the
conversation, the better your chances of choosing the right path.
Mycoskie calls his business, Philanthropic Capitalism. The company
makes a profit, but it incorporates philanthropy into its business model
and strategy. According to Mykoskie: “It’s important that we’re profitable,
and this year we will be for the first time, because that’s the only way you
can truly have sustainability. Ultimately, I’m trying to create something
that’s going to be here long after I’m gone.”25
If this is to occur, the question that Mycoskie and his company will
have to ask, again and again, is the following: What is the “deep truth”
about what these customers really value and how can the company develop
its value proposition to continue to satisfy those needs?26

Summary and Conclusions

This chapter has looked at the way one entrepreneur, Blake Mycoskie,
built a business model around a customer value proposition that appeals
to customers’ higher level goals. The vision he offered was so compelling
60 BUSINESS MODEL DESIGN AND LEARNING

to customers that he was able to reduce the costs of marketing in his

business model and cover the costs of giving away shoes to children. Sales
took off immediately and are still going strong. Currently, the company is
trying to strengthen its relationship with its customers, and is continually
adding new shoes, as well as other products, including glasses, in an effort
to stay in tune with customers’ tastes and stay ahead of competitors.
In the long run, however, the company will have to confront ethical
questions about its policies of bringing free shoes into the Third World
countries. As the Nike example shows, these questions will get louder and
stronger as the company continues to grow. In addition, new concerns are
likely to arise given the company’s status as a global orchestrator business.
As Robert Reich says, companies like this are no longer really “American”
companies. They’ve become global networks that design, make, buy, and sell
things wherever around the world it’s most profitable for them to do so.27
For TOMS’ business model to be sustainable in the long run,
customers will have to continue buying TOMS shoes and apparel and
they will have to continue to believe that by purchasing from TOMS,
they are part of something that is good for the world. In other words, they
must become part of the business model. In addition, customer input
may be crucial to revising and renewing TOMS’ model over time in a way
that fits with changing values and societal norms.
In the next chapter, I tell the story of a firm that chose not to listen to
its customers. In fact, it is a company that is well known in a positive way
for its powerful business model—Netflix.
 CHAPTER 6

Netflix Cancels the Value

Exchange Agreement
In Chapter 5, I talked about some of the steps that TOMS is taking
to sustain its value relationship with customers. As Figure 6.1 shows,
the value exchange relationship is both an agreement and a relationship
between firms and their customers. A strong relationship is one where
both parties are satisfied with the outcome of the exchanged values,
whether these outcomes are social or economic. Exchange theorists also
contend that all relationships require some time and effort on the part
of the parties involved.1 In fact, once established, this relationship is so
important to your company that I believe that you should build it into
your business model.
The reason why you need to focus on this relationship in your busi-
ness modeling efforts is because you are never in total control. According
to social exchange theorists, people review and weigh their relationships
in terms of costs and rewards.2 If your customers determine that the
benefits of purchasing your products do not outweigh the costs, or that
someone else is providing superior benefits at the same cost, they will
abandon you and move on to another provider. Netflix learned this les-
son the hard way when it angered its most loyal customers by abruptly
announcing a radical change in its pricing policies for DVDs by mail
and by streaming.
Netflix’s original business model, unlimited DVDs by mail for a
subscription price of about $9.99 per month, is a textbook example of
a model that raised the bar on customer value and transformed an entire
industry. Once Netflix came on the scene, it wasn’t long before the former
industry leader, Blockbuster, went bankrupt. Netflix offered a wider variety
of films, at a lower price, delivered to your door. Eventually, it introduced
instant streaming of a smaller selection of films as a free addition. It was a
62 BUSINESS MODEL DESIGN AND LEARNING

Firm Customer
Value
aspirations aspirations
proposition
& goals & goals

Figure 6.1. Value exchange relationship.

winning combination and one that customers appreciated. The firm had
a large and growing base of loyal customers.
In July of 2011, the company announced that it was splitting
the streaming business from the DVD business and converting them
into separate divisions. Now, customers could purchase unlimited
streaming only at $7.99 a month and unlimited DVDs at $7.99,
resulting in a $15.98-per-month subscription charge for both. That
resulted in a sudden 60 percent price hike for its current customers.
This sudden change shattered the value exchange agreement. Custom-
ers revolted. Within 3 months, the company lost at least 800,000
customers.3 Stock prices plummeted. A year later, they have fallen
even further.4
What Netflix failed to realize is that at this stage of its evolution, its cus-
tomers are now a key part of its business model. According to strategy guru,
Gary Hamel, value creation and value capture occur within a value network,
which can include suppliers, partners, distributors, and coalitions that extend
the company’s resources. This network also includes the firm’s customers.5
If Netflix had considered its current customers to be part of its model,
it might have avoided making decisions that angered them. One impor-
tant purpose of a business model is to help managers consider the logic
and internal consistency of their strategic decisions.6 Business models can
help managers avoid making ill-conceived decisions by forcing them to
consider a range of decisions holistically.7 This is the utility of the business
model as a conceptual tool.
Although Netflix implemented its business model foundations and
also differentiated itself brilliantly for years, I contend that it never
 NETFLIX CANCELS THE VALUE EXCHANGE AGREEMENT 63

paid much attention to its value exchange agreement with customers.

Instead, once new competitors began to emerge, it revised its original
model and value propositions, with too little effort on sustaining the
customer relationship. As a result, the company’s reputation was ruined,
and its credibility shattered.8 On the day that the new pricing scheme
was announced, over 4,100 comments were posted on Netflix’s own blog
page, most of them glaringly negative.9 Moreover, thousands more nega-
tive comments were posted on Twitter and Facebook.
Yet, if we consider the underlying economics of the fundamental
Netflix business model, we can see why the company wanted to make
the change. The lesson here is that once customers buy into your value
proposition, you can’t just arbitrarily change the deal. In the next section,
we look more closely at the logic behind Netflix’s decision to change, and
what it might have done to sustain its relationship with customers.

A Winning Business Model Versus

Forces for Change
Let’s review Netflix’s business model as of 2010 and consider the factors
that led to this change. With regard to key resources, the company had
built a huge library of over 75,000 films on DVDs obtained through part-
nerships and agreements with a broad variety of movie studios and televi-
sion networks. Its key processes were innovative and cutting edge from its
red mailing envelopes, which accomodated both customer delivery and
returns, to its easy-to-navigate website.
A key process in the winning Netflix model was the recommendation
algorithm, which leads customers to a wide array of films based on their past
preferences. This algorithm not only helped customers find good movies, but
also helped the company leverage its film library by reducing demand for cur-
rently popular titles.10 Interestingly, the company acquired the algorithm by
offering the Netflix Prize—a million dollars to the programmer or team who
could develop an algorithm that would meet specified accuracy goals based
on customers’ past preferences.11 This is an excellent example of open inno-
vation, which involves bringing in new ideas from outside your company.12
We should also consider the company’s profit situation prior to its sudden
pricing change in 2011. That year, Netflix had over 22 million subscribers.13
64 BUSINESS MODEL DESIGN AND LEARNING

As I mentioned earlier, it was charging its customers $9.99 per month for
the basic, unlimited mail delivery, and streaming combination. And it
earned $320 million profit on $2.1 billion in revenue based on providing
both of these services.14
It was about that time that new entrants such as Hulu and Amazon
Prime were coming on the scene. These competitors provided video
streaming only and did not have to carry the large infrastructure needed
to store and mail the DVDs. Although it cost more to buy the rights to
stream a film than to buy the DVD and rent it, Netflix believed that
streaming was going to become the new norm. And it needed more
money from customers if it was going to spend more to lease additional
materials for its streaming service.15 In addition, getting rid of the mailing
infrastructure could help balance those higher costs. So it began to look at
its profit margin and its overall cost structure in a different way.
To complicate matters more, with the new entrants coming along, the
television and movie studios now had more distributors to choose from,
which increased their power to increase prices. And those with their own
cable networks were starting to see Netflix as a competitor, since some cus-
tomers were quitting cable in favor of renting movies through Netflix. For
Netflix, this meant that the industry was in flux and that deals were getting
tougher. Early in 2011, it lost its Disney partnership. Later on, it lost Sony.
As Figure 6.2 shows, using the differentiated business model lens, the
new pricing structure that Netflix announced in April of 2011 was really
just the tip of the iceberg in terms of the real changes to come in its busi-
ness model. The new structure was designed to attract streaming-only
customers, and possibly to reduce DVD customers. The problem was that
the old arrangement—unlimited DVDs and streaming—had given its
current customers the best of all worlds, a huge library of DVD selections,
with some extra goodies available by streaming. To customers, it seemed
that Netflix ripped away this value with seemingly no regard for their
preferences. This huge reduction in value led to a huge customer revolt.
In the months following the customer rebellion, Reed Hasting, the
CEO of Netflix, stated that he had been guilty of overconfidence and of
“moving too quickly.” But he said he still believed—as do most investors
and analysts—that Netflix’s future lay not in DVDs but in streaming over
the Internet. “We still need to move quickly in streaming,” he said.16
 NETFLIX CANCELS THE VALUE EXCHANGE AGREEMENT 65

ed
g t • Separated video delivery and
l i x han rgo
etf ey c d fo ers) streaming businesses
N th an om
w l s t • Move to focus more on streaming
ho de cu
d mo eir
(an eir t th
th ou
ab Key
processes
2 1

• Loss of key Netflix’s • Changed value

partnerships Key Value
aspirations proposition and
resources proposition
& goals customers revolted

Profit
formula
• Essentially doubled the price
• Move to streaming meant
• Lost ability to focus on what less cost of materials
customers want • The increase in margins could
• Focused too much on profits not offset loss in quantity

Figure 6.2. Netflix changes its business model.

When asked if he had discussed the change with customers, prior to

its announcement, he said he was not sure whether the plan had been pre-
sented to customer focus groups before it was made public. According to a
New York Times article, “Mr. Hastings said he assumed it had been. But he
said he did not recall what those focus groups had said about the plan.”17
What Hastings forgot was that the company’s initial success in estab-
lishing the Netflix DVD delivery model was always based on what it
learned from its customers. The Netflix prize elicited brilliant ideas from
software teams far and wide. And then, using this crowd-sourcing algo-
rithm, the firm had strengthened its relationship with customers by using
their past choices to influence their future purchases.
Hastings was undoubtedly right that Netflix needs to move into
streaming video. However, he may have been wrong about the need to do
it so fast. He seemed to dismiss the value of his relationships with millions
of customers when actually they would have been happy to help him figure
out how to make the move forward. When streaming was first introduced
on a limited basis, customers were getting additional value—instant
streaming combined with a deep reservoir of movie titles on DVD. In fact,
the gradual addition allowed customers to learn how to add the hardware
66 BUSINESS MODEL DESIGN AND LEARNING

they needed to build their systems. The company could have continued
this evolution and even allowed their customers to generate feedback and
new ideas, perhaps even with regard to how to change the pricing mecha-
nisms in ways that would still benefit users. Perhaps the firm could have
offered different pricing options, at least for some period of time.
There are many reasons why you should include customers in your
business modeling decisions. Because they always have the choice to
leave, you need to find ways to nurture the relationship and adapt your
offering to meet their evolving needs. A simple step is to continually ask
them for input on how you can do a better job.18 In addition, once you
have them, you may realize that they are an actual resource; for instance,
letting them promote movies to each other might increase rentals of some
films. Finally, if you are sincere in your efforts to learn, you may find that
customers can actually help to generate new value propositions, attract
new paying customers, or generate new sources of revenues.19
Netflix was famous for its algorithm that captured customer preferences
and recommended films you might like, but it has been very slow in using
its website to create any kind of conversations or social community. I think
it could learn a bit from TOMS here, and other businesses that are greatly
benefitting from this kind of customer engagement. Incorporating custom-
ers in your business model is more complex, but it opens your eyes to their
perspectives and allows you to learn from their behaviors and inputs.

Summary and Conclusion

This chapter reviewed the Netflix business model before and after its
customer and stockholders rebelled. The company’s development of its
DVD by mail model was brilliant, completely changing the game in
the video rental industry. When the emergence of new streaming tech-
nologies and competitors threatened to disrupt this model, CEO Reed
Hastings moved quickly to transform and renew the company’s business
model, but he did so without attending to the value exchange agreement
the firm had established with its customers. As a result, the firm’s reputa-
tion was damaged.
Yet, Netflix is a large company, with many customers, and today, its
customer base is growing again. The mistake discussed here may just be a
 NETFLIX CANCELS THE VALUE EXCHANGE AGREEMENT 67

growing pain or an adolescent stumble in a terribly uncertain competitive

environment. Application of an adaptive business model lens might help
companies such as Netflix to do a better job of incorporating their cus-
tomer relationships into their strategic considerations. Customers can be
sources of information and learning, possibly making change easier in
the future. Learning can be difficult, but whatever it takes, keep learning.
The next chapter looks at Rent-the-Runway, a firm that has applied a
Netflix-type model in a very different industry, designer clothing rentals. The
interesting part of this story is that the two entrepreneurs who started this
business have built in learning and customer relationship development at
every opportunity from the very beginning.
 CHAPTER 7

Rent the Runway

Changing Customer Behaviors
and Industry Norms

When Jennifer Fleiss and Jennifer Hyman started Rent the Runway (RTR)
in 2009, they wanted to provide women with “aspirational products from
top designers” that they might otherwise not be able to afford.1 In 2012, the
firm has over 3 million customers and is adding about 100,000 new mem-
bers each month. RTR members typically range from 15- to 35-year-olds.2
To use the website, you must first become a member, which is free.
This gives you access to over 25,000 dresses and 4,000 accessories in sizes
0–16 with rental prices ranging from approximately $30 to $250. Each
rental includes a backup size at no additional cost to ensure fit, and cus-
tomers can also get a second dress style with their order for an additional
$25, plus an optional $5 insurance fee. To return the dresses, you slip
them into the enclosed envelope and drop it into the mailbox. It’s a lot
like the Netflix model, before streaming.
But unlike Netflix, this new company leads the way in incorporating its
customers into its business model while, at the same time, using its model
to shape customer behavior. RTR is part of an evolving value network
that is changing retailing forever, and it will be interesting to see how long
this company can ride the wave, and to what extent it will actually lead
the way. In such a dynamic situation, competitive threats can emerge sud-
denly, and from unexpected directions. In this chapter, I first examine the
firm’s differentiated business model, and then show how it interacts with
customers and builds customer relationships by using the adaptive model
as a lens. I also explore how RTR’s business model and others similar to it
are impacting retail in general, and how these new models have potential
to add to the woes of many traditional retailers in the next few years.
70 BUSINESS MODEL DESIGN AND LEARNING

Building the RTR Customer Value Proposition

Figure 7.1 presents an overview of RTR’s start-up approach and its
differentiated business model.
Leadership and vision. Jenn Hyman and Jenny Fleiss met on the first
day of class when they started Harvard’s MBA program after several years
of industry experience, Hyman in marketing at Starwood, and Fleiss in
finance at Morgan Stanley and Lehman Brothers. They were in their second
year of their program when Jenn got the idea for a business after watching
her younger sister trying to make up her mind about buying an expensive
dress for a wedding.3 After she and her friend, Jenny, talked about the idea,
they decided to go for it. “We had an idea, we thought that it was fun, we
decided to start working on it,” says Hyman. “We never had a business
plan. We pretended that we had a business from the very beginning, as
opposed to planning and strategizing as to whether it would work.”4
To test the idea, they bought a truckload of dresses, with their own
money, and offered to rent them to undergraduate students at Harvard
and Yale. The students snatched them up.

• Cheap advertising through website

and social media
• Storage, service, and shipping from
warehouse in New York
• In-house website development
• Data mining

Key
processes
2 1

• $30 Mil in funding • Huge selection of

Key Fleiss Value designer dresses
• Access to good and
resources proposition for rent
advice and feedback hyman
• Community of users
• Relationship with
designers

Profit
formula
• Price is 10% price of retail
• Optional subscription price
• Harvard MBA students • Solid inventory management
• Energetic and well connected and low overhead
• Met with over 50 professors

Figure 7.1. Rent the Runway differentiated model.

 RENT THE RUNWAY 71

“While Ms. Hyman watched, a girl tried on a silver-sequined Tory

Burch mini-dress, twirled in front of the mirror and turned to her
two friends to exclaim, “Oh my God, I look so hot!” “Her two
friends ran to the racks and rented as well,” says Ms. Hyman. “We
saw the power of women influencing each other.”5

Once they received their MBAs, they started meeting with designers about
the idea. “The first designer we met with was interested, and after that,
we jumped right in,” says Fleiss. They used the same energy in seeking
connections with the media, leveraging their contacts, and meeting
with anyone who would respond. Eventually they met a New York Times
reporter who liked their concept. The story she published drove over
100,000 members to their site in its first week and they exceeded their
first year projections in the first month.6
After seeking out a venture capitalist, the pair launched the website
in November of 2009.7 Eventually the company raised over $30 million
in funding.8
Key resources. As Harvard MBA students, Jenn and Jenny had access
to many knowledgeable people. In addition to conducting focus groups
and running tests, the team met with over 50 professors at Harvard
Business School, whether they had taken classes with them or not. They
asked for and received a great deal of advice and feedback.9
Designers are another key resource. Designers are to RTR what
the studios are to Netflix. Without the consent of designers, who are
highly selective about their distribution channels, the business model
would not have flourished. Luckily, designers embraced the concept as it
allowed them to “reach a larger audience and age demographic without
jeopardizing the brand.”10
The company began with 1,000 dresses from 25 designers in the first
year. It now has 25,000 dresses from 150 designers, including prominent
designers Diane von Furstenberg, Zac Posen, Helmut Lang, Kate Spade,
and Hervé Léger.11
Key processes. The company keeps its advertising costs in check by
making smart use of its website and social media. Photographs are a huge
part of RTR’s popularity, with at least 10 percent of customers posting
them on its Facebook page or website.12 As an incentive for posting, other
72 BUSINESS MODEL DESIGN AND LEARNING

customers can “like” your photos, and getting hundreds of “likes” from
people across the country can be exciting.
Logistics is another key process with thousands of units of inventory
being sent out, over and over. To manage their inventory of designer dresses,
and again control costs, all dresses are stored, serviced, and shipped from one
large warehouse in New York City. Inventory management has been out-
sourced to Slate NYC, a full-service dry cleaner, which helps keeps the dresses
looking and feeling newer for longer. Dresses are retired after 8–15 wears.13
Originally, the firm outsourced its website development, but manage-
ment recently added a full-time technology leader to the leadership team.14
The website is always being updated to help customers find dresses that would
look good on them. Members can upload their measurements to help assess
fit, and they can also chat with stylists or even other site users about what the
clothes feel like, what cuts and sizes would be best for their body types, and,
ultimately, what they might look like in a beautiful couture outfit.
Data are mined to determine how often the dresses get rented, and
which dresses are popular with different age groups and in different
geographic areas. For instance, dresses from designers such as Lela Rose,
Milly, and Shoshanna, which are more feminine and conservative, tend
to be more popular in the South while boho-chic styles tend to be more
popular on the West Coast.15
Profit formula. Information about the firm’s profit formulation is
difficult to find, but the company purchases its dresses at wholesale and
maintains an inventory of 25,000 current and recent-season dresses that
mostly cost between $400 and $2,000 at retail. Generally, rentals are
priced in the neighborhood of 10 percent of the retail price.16 According
to Reuters, the company had a revenue of about $6 million in 2010 and
it increased to $20 million in 2011.17 Quora reports that the company has
been profitable since March of 2011.
Customer value proposition. The value proposition for this company
is clear. The company offers young women a chance to wear beautiful
clothing at a very reasonable cost, and they make it easy to do it. You can
even be sure that your dress will fit because you get two sizes for the price
of one. When you’re done, you stick it in the envelope and mail it back.
The company also offers a subscription to make reserving a dress even
easier. For a 1- or 3-month period, subscription members can pick up as
 RENT THE RUNWAY 73

many dresses as they want without worrying about the incremental cost.
They also don’t have to worry about whether the dress they’re reserving is
a $75 Diane von Furstenberg or a $200 Herve Leger—they’re all covered
under the flat subscription fee.18
RTR keeps its costs low with careful inventory management and the
use of only one large facility. It constantly surveys customer purchasing
behavior to enhance the selection of dresses, designers, and sizes available.

How Does It Create Value for Customers?

Like the TOMS’ model, customers found value in this value proposition
right out of the box. The model is powerful, because it provides value
at several different levels of customer goals and aspirations. How does
it do it?
First, the company is obviously solving a problem for the customer,
and that is, what to wear on that special event, or what to wear when you
want to feel beautiful. In addition, at a functional level, RTR obviously
reduces the costs associated with finding the right thing to wear for an
event. You don’t have to drive from store to store searching for the right
dress, you don’t have to spend hundreds of dollars to buy it, you don’t
even have to get it dry-cleaned after you wear it—you just stick it in
the mail and its gone. As for benefits, the fun of choosing the dress, the
anticipation associated with wearing it, and the memories afterward are
all rated highly by customers. In fact, a customer survey showed that
members rated the emotional connection to the rental experience as more
important than functional benefits such as getting the garment for 8 days,
or getting an extra size for free.19
The strength of this emotional connection indicates that RTR is
satisfying customer’s long-term goals and aspirations and appealing to
their sense of self. RTR provides value to women by helping them define
who they are and establish how they want to be perceived.

Is the Model Sustainable?

Figure 7.2 shows RTR’s adaptive business model. I use this to discuss
changes and additions that are now being made to enhance sustainability.
74 BUSINESS MODEL DESIGN AND LEARNING

Key
processes
2 1

• Access to good, fitting,

Customer designer clothing
Key Aspirations Value
aspirations • Affordable price
resources and goals proposition & goals
• Community of women
with similar interest

Profit
formula

• Provide women with

“aspirational clothing from
top designers”
• Provide this at affordable price
• Make girls feel beautiful

Figure 7.2. Rent the Runway adaptive model.

Building and Leveraging Customer Relationships

Unlike Netflix, RTR irrefutably incorporates customers into its busi-
ness model. The firm strives to build an ongoing relationship with
young women, from high school prom days through college and
beyond and to provide them with an introduction to Alice & Olivia,
D&G, Missoni, Diane von Furstenberg, Trina Turk, and other design-
ers, who will assist them on the way.20 It places a heavy emphasis on
marketing to college campuses and a few elite prep schools, which
comprise about 25 percent of the company’s business, and are a big
source of its growth.21
A key process related to building customer relationships involves
recruiting a network of approximately 150 “runway representatives”
at 50 college campuses to promote RTR rentals before major campus
events. Sororities are key targets. These student representatives hold fash-
ion shows, build blogs and Facebook pages, and host rental parties in
exchange for building their resumes and getting discounts on their own
clothing rentals.22 Some schools even award college credit for this activ-
ity.23 This process of involving customers in sales activities is an excellent
example of how a company can integrate the customer base into the
 RENT THE RUNWAY 75

business model. It has worked so well that RTR is planning a similar

system for prep schools.
The company’s Facebook pages also create opportunities for
customers to discuss events they have attended and how they styled
their particular outfit. Says Fleiss, “Natural dialogue is happening
between our consumers.”24 Surprisingly, 15–20 percent of their users are
men who want to rent a dress for their girlfriends.25 By chatting with
female customers online, they can get a better idea of what type of
dress they should order. This idea of customers helping other customers
choose styles is also an example of customers assisting with selling the
RTR product.
Fleiss and Hyman also use RTR’s social media sites as opportunities
for learning from their customers. Both actively participate in RTR’s
social media efforts, hosting “style chats” on Twitter with consumers to
get ideas and style tips. It was a customer who gave them the idea to prealter
all their gowns in three lengths, and the company implemented it imme-
diately.26 They also take part in “style counsels,” where they post dresses
on RTR’s Facebook page after designer runway shows and ask customers
to vote on which ones they want purchased for the website. According to
Jenny Fleiss, “Essentially, we’re incorporating them into our buying pro-
cess, in which their feedback is instrumental in choosing what products
we decide to offer on our site.”27
Finally, the company recently hired Maxymiser, a firm that special-
izes in multivariate testing, personalization, and optimization solutions
to conduct comprehensive website testing. “Rent the Runway is truly an
innovative and progressive online business,” said Mark Simpson, founder
and president of Maxymiser. “Not only will we help them deliver a better
online customer experience, but we can also help them better understand
who their customer is based on certain shopping criteria like previous
searches, rentals, time of day, demographics, geography, and more. At the
end of the day, when you know your customers better, you’re able to serve
your customers better. It’s as simple as that.”28
Jennifer Hyman agrees that the use of personalization, big data, and
social networking is making it easier to find what you want, but in the
end, she contends, it’s the human touch and the interaction between
shoppers that separates RTR.29
76 BUSINESS MODEL DESIGN AND LEARNING

How the RTR Rental Model

Is Changing Industries
The essence of the RTR business model is the belief that the firm can
change the way that women think about buying clothing—particularly
for special events. Both leaders talk about the wisdom of investing in
basics, like a little black dress that can be worn many times, while renting
dresses for occasions, where one should never be seen with the same dress
twice. In addition, they stretch the idea of a special event to include
anything from formal dances, to first dates.
As I have said throughout this book, every now and then, a new
business model comes along and transforms our old ways of doing things.
Netflix did this in the DVD rental industry and as a result it forced Block-
buster and many other video rental stores out of business. The Netflix
model may do it again in the retail clothing industry but for a different
reason. Customers have been renting movies for years; Netflix just made it
easier. But for most women, the idea of renting fashion ware is a new one.
In the clothing industry, RTR is a leader in the promotion of collaborative
consumption. Collaborative consumption is a type of business model in
which shared goods or services are distributed via a market place to a
community of users.30
According to Tomasz Tungez in the MIT Entrepreneurial Review, col-
laborative consumption reshapes markets by changing supply and demand
economics. Using Zipcar as an example, he points out that these new mar-
ket places shrink consumer retail demand since each shared car eliminates
5–20 cars from circulation.31 Similarly, he says, a college textbook rented
10 times over its life will replace between 5 and 7 new copies.
Collaborative consumption also has potential to increase demand
and the total market size by addressing new previously unaddressable
segments.32 Until RTR came along, for instance, women in Starkville,
Mississippi or Stillwater, Oklahoma could not easily acquire designer
gowns at affordable prices whenever needed.
In 2011, Time Magazine called collaborative consumption one of the
10 ideas that will change the world.33 It is likely that the emergence of this
model in many different industries may have been inspired by customers
in their twenties and early thirties who have had a tougher time in the job
 RENT THE RUNWAY 77

market, and who carry high levels of college debt. According to a recent
article in Bloomberg Businessweek, many members of this generation are
insecure about the future and prefer to rent what they need when they
need it in order to stay flexible.34
Like Zipcar, RTR’s collaborative consumption model is a business to
consumer version. More recently, peer-to-peer options are emerging. For
example, women could share clothing with other women, and families
share houses, sometimes free, sometimes for a fee. These models are very
inexpensive to get off the ground because, instead of purchasing assets,
you get them from the community, often in exchange for a revenue share
of the transaction.35
With these trends converging, it is highly likely that the effects of
collaborative consumption modeling are just getting started. As Botsman
and Rogers state, it is a “socioeconomic groundswell” that will transform
the way companies think about their value propositions—and the way
people fulfill their needs.36

The Long-Term View for RTR

The future for RTR is certainly not assured, given the many changes that
are now taking place as business models collide and erupt around them.
Yet, they are doing many things to enhance their learning and adaptability.
First, the leadership team has proven that it listens. They are adept at
using their business model as a learning tool and involving their growing
customer base in the process. They use technology to study customer pur-
chase patterns, they survey customers directly about features and benefits,
they hold live chats on Twitter, they facilitate conversations on Facebook, and
they connect customers with each other to converse about the products.
Both on their websites and on college campuses, customers are selling
their products to other customers!
The company is also experimenting with a new way to gain customer
feedback by opening a small retail storefront in New York City, thereby
changing the business model from online only. This shop allows women
to try on clothes by different designers to understand which styles fit their
body types, and work with stylists to gain new ideas and perspectives as
they make their decisions.
78 BUSINESS MODEL DESIGN AND LEARNING

Of course, the RTR leadership duo also has to pay close attention
to the many types of new competitors that are emerging rapidly. For
instance, Girl Meets Dress is a U.K. firm with a very similar model, and
Ilus is a New York City retail store renting luxury dresses based on the
original men’s tux rental approach, which is a legitimate substitute for
women who would prefer to try the clothes on.
RTR executives are aware of the ongoing industry evolution and are
thinking strategically about the future. They have recently introduced
bridal wear into their lineup and they are promoting dress and accessory
rentals for all occasions surrounding the wedding, from the engagement
party to the bridal shower and honeymoon. Their research shows that
brides tend to buy an average of six dresses each for their weddings. They
are hoping to change this behavior.
When asked about their future direction, they referred to the many
different options that they may consider. “When we think about which
product categories we should extend into or which demographics we
should go after, or even which countries we should consider, it’s all about
kind of balancing that in a strategic and thoughtful way.”37

Summary and Conclusions

This chapter has focused on the story of how two Harvard MBA students
spotted an opportunity to create a new type of value for customers want-
ing to look beautiful at a special event. The team has built a business
model that not only meets these needs, but also incorporates customers
into their decision making and promotional processes. In addition,
the RTR model has introduced a big change into the traditional retail
clothing industry by teaching women to rent as opposed to buy certain
types of clothing. This transformation is another threat to an industry
that has already been under siege from a growing cadre of new online
competitors.
In the next section, I talk about J.C. Penney, a grand old dame in the
retail department store segment, and I look at its struggle to change gears
and reshape its old business model.
 CHAPTER 8

J.C. Penney’s Big

Experiment
In the past several chapters, I have used three different business model
lenses to talk about how firms create, deliver, and capture value. I have
also explained the logic that companies use in making decisions about
their business models, and have talked about ways that new models can
transform industry environments. In fact, a key theme across many of
these stories is that new business models are emerging more quickly than
ever before and that old models are being undermined as a result.
A key takeaway is that regardless of how great your business model
is, it won’t work forever. A recent blog by Ron Ashkenas was called “Kill
your business model before it kills you.”1 In it, he pointed out that Kodak
hung on to its film business long after the introduction of digital media
and AOL knew that dial-up subscriptions were declining far before it
took action. The moral was that many firms put off business model
change, even those that see the writing on the wall.
Changing your business model is difficult because it requires
changes in resources, processes, norms, and policies all across your
organization. It may also require changing the type of employees you
hire. And all of these changes must be made in a holistic fashion, so
that they are consistent and mutually reinforcing. These are compre-
hensive changes at a deep level. And yet, to succeed in the long run,
you must be ready and willing to take your company in new directions
when the situation calls for it.
Keeping a business model viable is a continuing task.2 A model
that is initially sound should withstand economic ups and downs but
can become dysfunctional if major discontinuities occur.3 In fact, it is
possible to envision a business model life cycle in which new models
are introduced, refined, adapted, revised, reformulated, and, eventually,
80 BUSINESS MODEL DESIGN AND LEARNING

rejected. When external changes undermine a model, it often cannot be

recalibrated; a new model must be constructed.4
Johnson, Christensen, and Kagerman describe five strategic circumstances
that often require business model change.5

1. To serve new or emerging markets. If you identify a group

of customers who have been shut out of a market, this may be a
worthwhile opportunity for developing a new model. Sometimes
customers have missed out because of money, but other times, it may
be due to lack of education or even lack of access. Rent the Runway
actually identified an underserved market of women who did not
have access to designer dresses easily or affordably.
2. To capitalize on new technology. If you have the opportunity to lev-
erage a new technology by finding a way to bring it to new customers,
then a new business model may be warranted. Netfllix saw streaming
as a new technology and changed its business model to make it work.
Unfortunately, the firm forgot to consider its customers.
3. To bring a job-to-be-done focus where none exists. Bomgar found
a way to solve a major problem for customers who didn’t realize it
could be solved, by allowing computer technicians to tap into their
customers’ computers from a distance. This was an unmet need and
the company stepped in to fill the gap.
4. To fend off low-end disrupters. Netflix also saw the need to change
because companies such as Hulu, who had a much less expensive
infrastructure by focusing only on streaming, were entering the
movie rental market.
5. To respond to a shifting basis of competition. Over time, many
different developments and forces can converge to change the way
you compete in an industry. This is happening in many industries
today but one that has been hit particularly hard is the retail industry.
As we have seen in past chapters, new channels have opened up, as
well as many new forms of competitors.

The next section explores how one competitor, J.C. Penney, is

attempting to respond to this confluence of changes by transforming its
business model.
 J.C. PENNEY’S BIG EXPERIMENT 81

J.C. Penney Background

J.C. Penney was originally founded in 1902 by James Cash Penney
in Kemmerer, Wyoming, where it sold clothing to frontier miners,
farmers, and their families.6 Originally, Penney called his store the
Golden Rule because he believed in treating others the way he himself
would want to be treated. From this small beginning, the firm rose to
become the second largest retail chain in the world, following Sears. At
its height, there were 2,053 Penney stores across the country, down to
about 1,100 in 2012.
A quote from a 1908 advertisement gives a glimpse of the firm’s
original customer value proposition:

We are here to stay; we like the country—its people; we believe

in selling you good dependable goods on a Small Margin of Profit
Only. We will supply you with durable and comfortable wear-
ing apparel cheaper than ever before. You will get BIG VALUES
for your money at this store. Let competition say what she will.
A comparison of values is all we ask… Our aim is to sell you
Reliable, Staple, Dependable Merchandise at a less price than any
other house in the country.7

As this quote shows, J.C. Penney got its start by providing its cus-
tomers with quality clothing at lower prices than the competition, and it
kept this same basic value proposition for a hundred years. The fact that
this company is 110 years old suggests that it has been highly effective at
adapting and transforming its business model over time as the industry
evolved and as competition grew.
Today, J.C. Penney is categorized as a department store chain, mean-
ing that it offers an array of goods, usually with different brands, organ-
ized into departments. Generally, they not only emphasize apparel and
shoes, but also have departments that carry anything from jewelry and
makeup to home furnishing and kitchen items. Appliances and other
hard goods such as hardware are less likely to be included.
The department store business is under increasing pressure these days,
which I explore in the next section.
82 BUSINESS MODEL DESIGN AND LEARNING

The Rise (and Fall) of Department Stores

and J.C. Penney in Particular
When they emerged in the late 1800s, department stores had everything from
restaurants and tea rooms, to art galleries, live music, and fashion shows.8
The original competitors, such as Macy’s and Lord & Taylor (New York),
Marshall Field (Chicago), and Jordan Marsh (Boston), were located in cities
around the country and were dubbed palaces of consumption.9 For most of
the 20th century, they reigned as centers of commerce and hubs of social
activity.10 They were where people shopped for everything from clothing and
jewelry, to electronics, home goods, and appliances. According to Lewis:

During this period, much of the U.S. population resided in rural

areas, far from these “palaces.” These original department stores
offered such an overwhelming and compelling experience that
those rural families would tear themselves away from the Sears
catalog, the Internet equivalent of the time, to travel for hours
to these beautiful and exciting stores and to spend the entire day
enjoying and probably spending more, just for the experience.11

Part of the allure of these early department stores was their atmos-
phere and decor, making the shopping experience a form of entertain-
ment. At one time, these stores were the fashion monitors of the day and
led the way with new trends in retailing. They were the first to provide
consumer credit and to create mass-produced clothing, and they became
the home for national fashion designers.12
J.C. Penney did not start out as one of these palaces of consumption.
As noted earlier, it was founded in the rural west, as a clothing store tar-
geted at working families, and it initially morphed into a mass merchant,
carrying home appliances, hardware, auto supplies and service, and the
like along with its clothing and home goods. This format helped it to
expand quickly across the country, locating in large and small cities alike,
but mostly attaching itself to suburban malls. It was not until the 1980s
that Penney’s actually repositioned itself as a department store, eliminat-
ing many of the hard goods based on the premise that customers don’t go
to malls to buy washing machines.
 J.C. PENNEY’S BIG EXPERIMENT 83

Ironically, it was at about that same time that Walmart and a new
cadre of mass merchants began stealing customers away from department
stores with their everyday low prices and wide assortment of merchandise.
Target added to the competitive mix by enhancing the selection and
shopping experience in a mass merchant setting. T.J. Maxx and Ross
Stores also leaped into the fray with their discount “department” store
models, offering similar goods to department stores, but with less ambi-
ance and lower prices. A wide array of specialty stores began to appear,
focusing on the latest fashions for the growing teen and student market.
Off-price and outlet stores popped up all around the country. With so
many new stores opening up, the sheer amount of retail space in the
United States skyrocketed in the last part of the 20th century. And then
in the 2000s the Internet exploded.
The growth of online stores, such as Amazon.com, and Zappos now
poses a major threat to the department store industry. Not only have
these web-based competitors stolen sales from traditional stores, but
they have also changed the way consumers shop. One analyst pointed
out that the growth of online sales is causing retail stores to change into
mini-distribution centers for the Internet. This trend is increased as retail-
ers put in place “buy online, pick up in store” programs such as Toys ’R
Us has done.13
The growth of so many new options, combined with the poor econ-
omy over much of the past few years has continued to wreak havoc with
traditional department stores. In response, the department store segment
has consolidated, with industry leaders buying weaker chains, leaving
only about 20 companies operating approximately 3,500 stores with
combined annual revenues of some $60 billion. Along with J.C. Penney,
major players include Sears, Macy’s, Neiman Marcus, Nordstroms, Saks,
and Dillard’s. Many of the stores have been striving to draw in custom-
ers by using heavy discounting techniques. Macy’s is a good example of a
department store that runs frequent promotions, but J.C. Penney’s may
have been the leader with over 590 unique promotions in 2011.
That year, Penney’s sales fell about 2.8% to $17.3 billion from the
previous year. For the first time, its revenues were surpassed by Kohl’s14
(also a heavy discounter), which rang up 18.8 billion in sales. Macy’s sales
for that period exceeded 26.5 billion. As a comparison, Walmart rang up
84 BUSINESS MODEL DESIGN AND LEARNING

over $446 billion in sales in the same period, almost as much as the entire
department store segment.15
In 2012, Penney’s also lagged behind Macy’s and Kohl’s in terms of
both gross margins and operating margins. Its sales per square foot of
$132 was only half that of Kohl’s and about 30% below Macy’s.16
From this brief description, several points deserve attention. First,
J.C. Penney evolved from a little store in Wyoming to the second largest
retail chain in the nation. Along the way, it first transformed itself from
an apparel store to a mass merchant to a department store. Yet, today,
the entire department store industry is in decline and is facing questions
about its relevance to customers. Moreover, Penney’s has fallen behind
other major players. Yet, while it’s $17 billion in sales in 2011 was far
less than Walmart, it was far more than Rent the Runway. And with over
1100 retail locations across the country, and with its strong history, the
firm would seem to have the resources to support a turnaround.

J.C. Penney’s Business Model Transformation

In 2011, Ron Johnson, from Apple, was hired to turn the company
around. Johnson, known both for designing Apple’s beautiful retail stores,
and for helping to establish Target’s aura of cheap chic, announced that
he would treat the chain “like a start-up company”17 by reformulating its
business model and reinventing the department store. To assist him in
revamping the stores, he installed Michael Francis, another former Target
executive, as J.C. Penney’s brand president.
The first question to ask about the change at J.C. Penney’s is whether
this is truly a business model change versus a strategic repositioning. If we
consider only the most basic elements of its business model, or the foun-
dation, we might say that not much has changed. The company is still a
department store with a chain of retail outlets, a broad array of goods, and
supporting online sales. However, if we consider the differentiated busi-
ness model lens shown in Figure 8.1, we can see that Johnson’s revision
is addressing every element in the circle, a sign that true business model
remodeling is occurring.
Leadership and vision. Fresh from his leadership stint at Apple,
Johnson attributes that company’s success to its innovative retail stores,
 J.C. PENNEY’S BIG EXPERIMENT 85

• More stores being leased

• Cutback in mailings, coupons, and promotions
• Special discounts
• New approach to advertising
• Move to mobile checkout devices

Key
processes
2 1
• Remodeling hundreds
of stores
• “70 new stores” • Fashion brands at
• Change from 18 to 13 Key Johnson’s Value everyday fair prices
supply chain locations aspirations
resources proposition • Providing value in
& goals
• Reduction in number of the “experience”
employees
• Change to more designer
brands
• New “jcp logo” Profit
formula
• Lowering cost structure
• Creating platform for growth
• Johnson’s experience at Apple • New targeted expense reduction
• Make Americans live and look • New sales objectives
better everyday • Cost cuts
• Reinventing what it means to be
a department store

Figure 8.1. Changes to J.C. Penney’s differentiated business model.

which succeeded when other computer retailers such as Gateway were

failing. “When you begin with a vision of enriching lives vs. moving boxes,
magical things happen,” he says.18 His vision for the new J.C. Penney is just
as compelling. He wants to help Americans live and look better every day,
and he wants to make J.C. Penney their favorite store.19 How? According to
Johnson, “We think the promotional model is going away. We’re going to
create a new category. We’re going to call it: the specialty department store.
It’s going to be profound,” he says.20
As opposed to trying to change J.C. Penney from a department store
to another type of retailer, Johnson is trying to reinvent what it means to
be a retail department store. And ironically, his changes sound a lot like the
original department store business model, from the 1800s, when depart-
ment stores were like self-contained mini-malls, with fashion shows, and
tea shops and live music. With his proposed store-within-a-store concept,
Johnson seems to be bringing the notion back to life.
Key resources. The company is completely remodeling hundreds of
stores, using the store-within-a-store concept. Each grouping is based on
86 BUSINESS MODEL DESIGN AND LEARNING

one brand-specific item or a collection of similar items. Widened aisles

will lead to a central location called The Square, where Wi-Fi and refresh-
ments will keep customers in the store.21 The 700 or so smaller stores in
the chain are getting some changes as well including a new store layout
built on small clusters. If all goes as planned, the company will open 70
new stores by 2014.
The company’s distribution system has also been streamlined from
18 supply chain locations to 13. The firm also operates six logistics hubs
that serve as the entry point for direct imported goods. Although these
will not change, two call centers have been closed. In addition, over 600
employees were laid off at the company’s Plano, TX headquarters, and
employees have been cut from the payroll at stores all across the country.
Commissions for its sales staff were also eliminated.
Traditional Penney brands, such as St. John’s Bay and Ralph Lauren,
have been dropped while new designer names such as Vivienne Tam and
Betsey Johnson have been added. The plan is to increase sales of national
brands to 75 percent versus the former 45 percent.22 Finally, the J.C.
Penney store brand has been replaced by a new “jcp” logo.
Key processes. In the new jcp stores, only some of the store groupings
will be run in-house, while a greater percentage will be leased to companies
such as Sephora.
Mailings, coupons, and promotions have been dramatically cut back
and replaced with an everyday, fair-and-square pricing approach in which
products are said to be priced at a level 40 percent lower than the for-
mer presale regular prices. Special discounts are offered on Fridays and
monthly discounts are in place for slow-moving items. This change from
a discounting to a fair price approach also allowed the firm to lower its
advertising budget by about $300 million a year.
To introduce its new approach, the company hired Ellen deGeneris
as its spokesperson. In another new approach to advertising, it included
images representing gay and lesbian parents in its mothers and fathers day
promotional materials. The idea was to promote all kinds of American
families.
The company also announced plans to replace its old-fashioned cash
registers with mobile checkout devices similar to those used in Apple
stores. jcp is also introducing self-checkout kiosks. It is even considering
 J.C. PENNEY’S BIG EXPERIMENT 87

the total elimination of cash purchases in the near future. jcp will also
replace the conventional bar-code tags with Radio-Frequency Identifica-
tion (RFID) tags that will enable customers to check out without physically
scanning individual items.23
Profit margin. By simplifying J.C. Penney’s operations, signifi-
cantly lowering the company’s cost structure and creating a platform
for growth, the company seeks improved profitability in 2012 and
beyond.24 Specifically, a targeted expense reduction of $900 million
was announced in January 2012 and a sales objective of at least of
$177 per square foot has been set for 2015. Although cost cuts to date
have been substantial, they have not yet paid off, particularly because
Johnson has undertaken to transform so many stores at one time, an
expensive proposition.
Customer value proposition. On the surface, the new value proposi-
tion is based on offering fashion brands at everyday fair prices in an excit-
ing retail environment framed by a store within a store concept. Restating
this, instead of providing a spot where customers can treasure hunt, or
look for bargains, jcp will provide a spot where shoppers will find value
in the experience, where they can get free haircuts, and sip coffee, and
use Wi-Fi, while not having to worry about coupons or digging through
sales racks.
Since this is a total revision of the former “popular brands at a dis-
count” proposition, the jury is still out concerning whether customers
will perceive this proposition as something of value. In other words, in
attempting to transform J.C. Penney’s business model in so radical a way,
Johnson is actually conducting an experiment worth billions of dollars to
shareholders. So the big question is: Will it work?
In May 2012, only 6 months into the change, it was announced that
company sales were down 20 percent. The next day, the company experi-
enced the largest percentage decline in stock price since 1929. Francis left
a month later, and Johnson took over the marketing responsibilities along
with his role as CEO.25
Johnson likened the turnaround efforts to a marathon. “We said this
would be a very tough year. I don’t think that got through,” Johnson
says.26 In the meantime, critics have questioned whether Johnson fully
understands the J.C. Penney customer.27
88 BUSINESS MODEL DESIGN AND LEARNING

What About the Customers?

The value exchange agreement between the new J.C. Penney’s and its old
customers as shown in Figure 8.2.
Johnson’s vision, shown on the left, fits with his past experience at Apple
and Target, and his knowledge of younger, style-conscious consumers.
Apple set out to change the world, and it did, so why shouldn’t J.C. Penney
change the way people shop? If Johnson’s changes are successful, the
J.C. Penney stores will be transformed into lifestyle stores that will appeal
to a younger customer who lives in a different world than the traditional
J.C. Penney customer.28
On the right side of the model, we have J.C. Penney’s core cus-
tomer base consisting of older, price-conscious shoppers drawn to
the company’s frequent promotions and deep discounts. They have
complained loudly about Johnson’s transformations. Like Netflix,
J.C. Penney’s appears to have abandoned its customer base in search
of new customers.
The most frequent customer complaints concern jcp’s new fair-and-
square pricing scheme. As some critics noted, the “price value” propo-
sition made to shoppers was very complex.29 Some merchandise was
labeled as “everyday value.” Other merchandise was discounted only on
first and third Fridays, a policy that was changed to every Friday after
only a few months. Coupons and promotions were eliminated despite
the fact that they had driven consumers into their stores for years. As a
result, many customers have abandoned Penney’s to shop in stores such
as Belk, Kohl’s, and Macy’s, all of which are promotionally driven, run-
ning sales on a regular basis, the same strategy that J.C. Penney used
to employ.30

• Transform shopping • Quality goods and low

experience prices
• Eliminate discounts Johnson’s Value Customer • Search for bargains
and coupons aspirations proposition aspirations
• Seek out known brands
& goals & goals
• Upgrade brands • Shopping at JCP is a
• Improve jcp image family tradition

Figure 8.2. J.C. Penney’s value exchange agreement out of whack.

 J.C. PENNEY’S BIG EXPERIMENT 89

Many customers have also complained about the change in the store’s
brands and product lines. The traditional J.C. Penney brands have been
replaced with new “fashion” brands. Customer comments in online discussion
boards repeatedly lamented the loss of valued brands and products, such as
Cabin Creek blouses for women, and St. John’s Bay trousers for men.
Another change that some customers didn’t like related to some of
jcp’s new advertisements. As one former Penney patron said to me:

“I didn’t mind seeing Ellen DeGeneres in the commercials because

she is a highly talented, and very funny woman. And she wasn’t
promoting her lifestyle so I could ignore it. These other ads with
gay couples were a different story. I haven’t been back to Penney’s
since. And that’s sad because we’ve always been a Penney’s family.
My grandmother shopped there and so did my mother.”

Whether you agree with this philosophy or not (and I don’t), it is

a fact that many of Penney’s stores are located in conservative, rural
communities. Taken together with the elimination of discounts, and the
shift in brands, these messages seemed to suggest that the new jcp value
proposition is actually aimed at a new customer base. As one analyst says,
the entire marketing mix seems to be out of sync with the jcp target audi-
ence. From the start, it appeared to be a strategy that came out of the
mind of Johnson rather than jcp’s customer base.31
Like Reed Hastings at Netflix, Johnson has clearly made decisions
that violate the chain’s value exchange agreements with members of its
current customer base. According to brand consultant Bruce Dybvad,
“Retailers pay a steep price when they break a sacred covenant. Leaders of
tomorrow will be those who effectively manage transformational change
with the participation of their customers and keep their promises.”32

Evaluating the Changes in J.C. Penney’s Model

Johnson, Christensen, and Kagerman pose several questions that can be
used to see if a new model makes sense. We can apply these to the new
J.C. Penney model.
90 BUSINESS MODEL DESIGN AND LEARNING

1. Does it contain a focused, compelling value proposition? At this

point, in thinking about the situation at Penney’s, I would say no. It
is not clear who the customers are or why they should come to the
stores. It does not seem to address the current customers at all.
2. Do all the pieces of the model work together to get the job done
in the most efficient way possible? When looking at the elements
of Johnson’s new model, there appear to be some inconsistencies.
Cutting staffing levels in the stores, for instance, may not be com-
patible with upgrading the service experience. Dropping well-loved
store brands to add fashion brands that other stores may be carrying
may not lead to differentiation.
3. Can you create a new model that is unfettered by the negative
influences of your core business? In this case, Johnson is revising
the entire core business, while still working within the fundamental
core department store format. One of the steps to making this huge
change involved removing many of the old store managers and install-
ing new ones. Although this sounds draconian, it may have been done
to ensure that the changes would be supported at the store level.
4. Will the new model disrupt competitors? The question is, why will
customers leave Macy’s or Target or T.J. Maxx, or Amazon, to shop
at Penney’s? The answer at this point is not clear. Johnson hopes to
do this by creating a department store model that entertains as well
as provides stylish merchandise. This hearkens back to the original
department store model from the 1800s, which was successful for
years. Perhaps its time has come again.

Business Model Change Is Difficult

Johnson has showed both vision and courage as a leader in attempting to
remake a great American company such as J.C. Penney’s. Although the ini-
tial results have failed to live up to expectations, there is no reason to expect
that the transformation of such a large company with such a long history
can be accomplished in under 2 years. The real lesson here is not about any
of the specific changes that Johnson has made or not made, but in the ideas
that all leaders must consider when striving to revamp their business models.
 J.C. PENNEY’S BIG EXPERIMENT 91

1. Business model change is like starting over—a new value

proposition is a new hypothesis and must be tested. The bot-
tom line is that business model change is extremely difficult for any
company. As with any start-up, a new business proposition is just a
hypothesis and so it must be tested with real customers to find out
whether it will be attractive or acceptable to them. Johnson’s test
was very risky because it included the entire enterprise. He has spent
millions on transforming stores. A safer path is to experiment on
a smaller scale, make changes incrementally, and refine and revise
along the way. Yet when a firm is publicly owned, this path may not
be possible.
2. Business model change is fundamental change. Changes across
the organization must be internally consistent and reinforcing.
Business model change not only involves new products and pro-
cesses, but it also involves changing rules and norms, and putting
new systems into place in a holistic way. While striving to upgrade
the jcp stores’ image and brands, Johnson also fired managers and
personnel all across the system, eliminated commissions, and low-
ered pay. Will these cuts allow him to provide the level of customer
service needed to support his new store image?
3. Business model changes require that clear messages be sent to
customers. jcp’s new fair-and-square pricing policy sounds a lot like
Walmart’s everyday low prices. And its store layout borrows some
ideas from Target. Its new advertisements are carrying signals about
family as well as the changes in the store. How do we make sense
of these messages? What do they say about the company’s identity?
Clarity is key in such a transformation.
4. Business model change may mean starting something totally new.
No business model lasts forever. Company leaders should always
be looking for new business opportunities to potentially replace
the current model. If you only invest in refining today’s business
model you’ll get locked into it. Testing, incubating, and investing in
alternative models hedges against that possibility.33 Perhaps Johnson
could have experimented with an entirely new venture, milking jcp’s
revenues to build the new model.
92 BUSINESS MODEL DESIGN AND LEARNING

5. The value of the change can only be determined by the customers.

Johnson wants to reeducate customers, change their approach to
shopping, and even make them look better. And while in theory it is
possible to “educate” consumers that coupons and sales don’t mat-
ter, as well as try to change their view of family values, experience
shows that attempting to modify consumer beliefs and habits is a
daunting task.34

Obviously, if it is to succeed in creating value for its shareholders,

J.C. Penney must create value for its customers. This means its new value
proposition should be able to answer two fundamental questions: Why
should J.C. Penney’s current customers continue to shop at J.C. Penney? and
Why should any of competitors’ customers switch to J.C. Penney? If it is not
able to retain most of its customers and attract new ones, J.C. Penney
may fade into oblivion, along with Marshall Fields and Filene’s and other
retailers that lost touch with their customers.35

Summary and Conclusion

The department store is in a precarious position these days, losing share
to many new types of retailers as well as online stores. J.C. Penney, at 110
years of age, is at the center of this industry and is attempting to revitalize
the industry with a new notion of customer experience and value. Inter-
estingly, this vision looks a lot like the original palaces of consumption
that initially defined the department store experience. It is ironic that
Penney’s with its working class roots is moving in this direction. It is per-
haps inevitable that the transformation is proving to be difficult.
Yet, the real bottom line is that all business model change is diffi-
cult. Some of this difficulty can be avoided if you include customers in
conversations about the changes. In addition, conducting smaller tests as
opposed to testing the change on the entire enterprise could have pro-
vided him with inputs about which changes were most effective in creat-
ing customer value.
The next chapter summarizes the lessons about business modeling
that have been covered in this book and draws some conclusions to assist
you in reducing the inherent risks of putting a new model into place.
 CHAPTER 9

Ten Key Ideas About

Business Models
I wrote this book to provide you with a practical approach to understanding
business models. To do this, I presented three business model lenses, the
foundation, the differentiated, and the adaptive business models. These
lenses can be used to guide your thinking about how to design an initial
model to experiment with and to assist you in evaluating the strengths
and weaknesses of your firm’s present model. To find the material to use
in writing this book, I studied academic articles, read popular books and
articles, searched online, followed blogs, and talked to my friends in the
business world. In this chapter, I describe 10 major themes that came
into focus for me as I did this work.

1. A business model is a conceptual tool.

It helps you think. It helps you evaluate. It helps you frame your
stories. The business model lenses shown in this book can help you
to consider ways to use the resources and processes at your dis-
posal to create something of value for your customers while mak-
ing money for yourself. They can be used as frameworks to lead
your examination of your own company’s processes and systems
and help you to determine which combinations of activities are
generating value, and which are not. They can make you think
about how you are going to earn money and what outcomes are
needed to meet your goals.
Business model frameworks, like the lens models described here,
are holistic models. That means they incorporate all of the elements
needed to create, deliver, and capture value. You can use them to clarify
the core logic behind your system.1 Although there are examples of suc-
cessful and unsuccessful business models, there is really no recipe for
94 BUSINESS MODEL DESIGN AND LEARNING

success. Every business model that I studied was shaped and molded,
and tested, and remolded by its leaders, as they struggled to find the
right combination of ingredients. Business modeling is not quite a sci-
ence these days; in fact, it is definitely part art.2
The basic elements of business model design include key
processes, key resources, a customer value proposition, and a profit
formula explaining how it will make money.3 In addition to these
elements, the entrepreneur or leadership team is also a key part
of the model, especially in start-ups, since the vision, values, and
capabilities of these individuals are often essential to establishing
the innovation or differentiation needed to form a unique model.
As we saw in Chapter 4, Martin Jue’s skills were clearly the key
to his firm’s ability to create a flow of innovative products while
keeping costs low. And finally, established companies are advised
to consider the customers and the customer relationships in their
business models.

2. A business model is also a system that is built into all the things
you do.
Once your business becomes an ongoing operation, once cus-
tomers begin buying your products, and revenues begin flowing,
your hypothesized business model will become built into your com-
pany. A business-model-in-use is a system that includes all the ele-
ments needed to create value for your customers and capture value
for you. This system includes the way that you manufacture your
products, the type of employees you hire, the brand that you choose,
and the policies that you set, and so on.
Often this side of the business model is hidden or unclear to
organizational participants. The reasons for many past decisions are
forgotten. To revitalize your company and your relationship with
your customers, you should take a hard look at everything you do
and ask yourself how it contributes to building or capturing value.
Chances are, you will find some things that no longer make sense.
Perhaps they used to be valuable, but they’re not now. Learning to
make your business model explicit is often the first step to improve-
ment or change.
 TEN KEY IDEAS ABOUT BUSINESS MODELS 95

3. You can use different business model lenses at different times.

Once you understand that a business model is a tool to help
you  plan, design, learn, and change, then it makes sense that you
need to use the right tool for the job. As your company grows and
becomes more complex, your model should too. The business model
foundation lens focuses only on creating and capturing value. It is
useful when you are generating your customer value proposition and
determining how you will make money, but it doesn’t consider how
you will compete. The value proposition for TOMS’ shoes promises
customers to give a pair of shoes to a child for every pair sold. The
vision is part of the value proposition.
The differentiated business model lens emphasizes a second
layer of decisions to be made, those that relate to distinguishing
your model from those of competitors. When you consider value
through this lens, you must consider how your firm’s deliverables
will be superior to those provided by others. And you must consider
how to avoid easy imitation. These considerations must be ongoing
since new contenders are always entering the picture. Once TOMS’
buy-one-give-one model became popular, competitors came out of
the woodwork. BOBS’ shoes were a direct imitation, but other compa-
nies such as Warby Parker Eyewear have copied the model in different
industries. TOMS will have to continue to find ways to differenti-
ate its company from imitators since this basic value proposition is
easy to copy. At present, its strong brand name is a differentiator. To
maintain that lead, it should continue to propagate its message, and
involve itself with customers, as well as serve as an exemplar of the
kind of good that companies can do for the world. I think that to
maintain this role, it will have to be absolutely authentic in its efforts
to be socially responsible, and it will have to be willing to redefine
what that might mean. Giving away free shoes may not be enough
in the long run.
The adaptive business model lens is a better business model for
a firm such as TOMS because it includes the customers as actual
parts of the model. TOMS’ leadership, under Blake Mycoskie,
is certainly having conversations about how to stay connected
with their customers and how to keep them interested in their
96 BUSINESS MODEL DESIGN AND LEARNING

humanitarian activities. This is very different from the approaches

used by Netflix and J.C. Penney, both of which made radical changes
to its business model without consulting customers. In contrast,
TOMS has already taken steps to engage its customers in changing
the world by supporting discussions on college campuses and invit-
ing volunteers to help deliver shoes.
Depending on where you are in the growth and evolution of
your business, you can use any of these business model lenses as
tools to help you design your business, or help you to study and
understand the business model that you have in place right now.

4. Always remember that the most important purpose of a business

model is to solve problems for your customers.
Your mission is to help your customers stop worrying and start
getting on with their jobs, or their lives. You do this by solving a
problem for them. Unless you can do this, and do it better than your
competition, you won’t be around very long. Joel Bomgar’s techni-
cian experience allowed him to see exactly what it was that frustrated
computer technicians and his computer science education prepared
him to do something about it. His product, the Bomgar Box, was an
immediate success. It offered a solution to a compelling problem faced
by computer technicians and helped them to serve the customers.
It is less clear what job the new J.C. Penney’s is trying to
solve for its customers. When someone wants to shop, there are
many different types of retail clothing stores, as well as more
glamorous department stores, and many new online stores. If you
don’t like those, you can go to Walmart or Target. When it comes
to shopping, there are tons of alternatives that serve the need.
So, the question is, what problem is the new jcp really trying to
solve? Some have speculated that the new model is designed to
entertain customers or to make the shopping experience more
pleasurable by simplifying the decisions to be made. It may be
true that people are seeking a different shopping experience in
this day and age.
With his experience and success in designing the Apple retail
stores, Ron Johnson appears to have a deep understanding of today’s
 TEN KEY IDEAS ABOUT BUSINESS MODELS 97

retail customers. If his solution works, J.C. Penney may indeed be

ahead of the curve.

5. Sometimes your customers can solve problems for you.

Many companies, including Rent the Runway (RTR), have
already figured this out. Customers are more than just the endpoints
in our processes. Customers can be resources. Customers can be
innovators. They can even help to promote and sell your offerings.
A key reason why RTR is able to rent dresses online with no
opportunity to try them on is because customers educate each other,
on the website and on Facebook, about how certain dresses fit, or
what body types they might suit.
Creating more ideas for customer collaboration can be an
important source of innovation. The adaptive business model accom-
plishes this by forcing you to think about customers as a critical
company resource. What they have to tell you is critical to ensuring
that you can outdo the competition.

6. Never forget that your customers are the ones who define what
is valuable.
An important thing to understand when crafting a business
model, or when reconsidering your model in use, is that value
is always defined through your customers’ eyes. Every customer
is motivated or driven to make a purchase by a complicated mix
of needs and desires. These include higher level goals and aspi-
rations, current concerns or jobs to be accomplished, and spe-
cific calculations about benefits versus costs. In general, if you
can increase benefits and reduce costs while solving a problem or
helping your customers fulfill their personal goals, you are on the
right track.
When considering the actual product or service, customers
weigh the costs and benefits. Benefits are everything that they like,
including how the product functions, or tastes, or feels, or looks, as
well as how it affects them emotionally, or physically, or cognitively.
Costs are the sacrifices they make to use the product as well as the
actual price that they pay.
98 BUSINESS MODEL DESIGN AND LEARNING

Your customers will often make trade-offs among these costs and
benefits when they choose to buy a product. Some will pay more to
get better quality or other benefits, while others may choose to drive
an hour to find a product at a cheaper price. Some customers may
choose to limit their access to an online service in order to get it for
free; others may be willing to pay for a stronger set of services.
Products that compete only on their specific ratios of benefits to
costs are more like commodities. Customers can search widely online
for such products, easily comparing features and prices. To overcome
this and to differentiate your offering, you need to find a deliverable
that is more personal, such as your relationship with the customer,
or your brand image.
The TOMS example shows us how even shoes can become
imbued with a higher purpose that appeals to consumers. These days,
there are many potential customers out there who are looking for a
way to contribute to making the world a better place. If you can solve
a problem and help a person feel good about himself or herself, you
have a better shot at making a sale. If you can reinforce a person’s
perception of herself as a good person, then your product benefits
will resonate.

7. Your deliverables include product, price, access, and the

transaction/interaction.
When you are trying to find just the right mix of features to
appeal to your customers, don’t forget that it’s not just the product
itself that matters. The deliverables that you bring to the market also
include access, price, and the transaction or interaction that occurs
when the product is purchased.
Sometimes access itself can be an important differentiator as it
is with both Netflix and Rent the Runway. Netflix knocked Block-
buster out of the industry when it started shipping DVDs directly to
customers’ doors. Then the firm’s management worried that stream-
ing was an even easier means of access and that customers would
prefer the option to download films immediately.
Price has always been important in the customer’s value
judgments, but now an array of new pricing mechanisms is emerging.
 TEN KEY IDEAS ABOUT BUSINESS MODELS 99

It’s not just the amount that you charge, but also the way you go about
doing it that matters. Some companies find that customers prefer
paying small subscription fees over time, while others provide some
services for free, and then charge for others. Some firms provide eve-
rything for free, and get their revenues from advertising. Some firms
have a combination of revenue streams. Like anything else in your
business model, finding the right pricing mechanism or pricing level
may be a matter of experimentation.
The customer relationship begins with the actual transaction
that occurs when your customer buys your product. This is called a
transaction when it only involves taking a payment and ringing it up.
It becomes an interaction when you communicate with the person
who is paying for your product and do so in a way that makes that
person feel good about doing business with you. Every transaction
has potential to become an interaction. When that happens, your
customers will not only feel positive about doing business with you,
but will change their behaviors in order to do it again. Some custom-
ers will stay with a service provider who is slightly more expensive
than others, simply because they enjoy the relationship.

8. Never stop experimenting.

Your customer value proposition is a hypothesis about what cus-
tomers want. It must be tested on real customers. Experimenta-
tion is key, for both new companies and old ones trying to make
a change.
Blake Mycoskie brought a duffle bag full of canvas shoes back
from Argentina and convinced a popular L.A. shoe store to carry
them. Jennifer Hyman and Jennifer Fleiss carried racks of luxury
dresses to students at Harvard and Yale to see if they would rent
them. In both cases, the products flew off the racks and they knew
they were onto something. Ron Johnson, in contrast, bet his entire
company in his transformation of J.C. Penney’s business model. That
is a risky path.
Experiments should be designed so that you can succeed even if
your experiment fails. In other words, keep your experiments small
if possible. Martin Jue used small, low-cost experiments as he built
100 BUSINESS MODEL DESIGN AND LEARNING

his ham radio business 40 years ago. Back then, he built a selectiv-
ity filter to enhance Morse code signals and ran an ad in a popular
ham radio magazine to try and sell it. In his next test, he made the
product more user-friendly, ran a bigger ad, and got a toll-free Watts
line. Although these tests occurred over several years, he learned not
only what his customers wanted right then, but also the importance
of listening to them.
Today, the testing concept is the same but the speed has
increased. What Martin did in three years can be accomplished in
months given the use of Internet sales and online advertising. Access
to customers is different. Investor expectations are also different. Yet,
we need to remember, although it is beyond the scope of this book,
that not all start-ups need to aim for the kind of growth demanded
by venture capitalists. Martin Jue insists that purposeful testing, per-
sonal investments, and frugal spending, while they may take more
time, can have very positive results because you end up owning your
own company.
The idea of testing your business model is also very important,
maybe even more important, for large established firms. When old
business models lose effectiveness, as in the J.C. Penney case, experi-
mentation is crucial. Yet, as Chesbrough points out, these experiments
are often resisted since they may initially result in lower returns.4 Wit-
ness the sudden resignation of the jcp executive after only 6 months of
that firm’s transformation. Experiments should be designed not only
in a way that involves real customers paying real money, but also in a
way that reduces the cost of negative results. J.C. Penney’s systemwide
experiment was a very expensive way to test customers’ perceptions of
the firm’s new ideas about customer value and pricing in a retail setting.
The four tests that you should consider from your initial busi-
ness model design until your firm is mature include feasibility (does
it work?), viability (will they buy it?), sustainability (will it last?), and
adaptability (can we change?).

9. New business models are emerging every day.

A major theme, cutting through all of the stories in this book, is
that business models are changing. In fact, we are in the midst
 TEN KEY IDEAS ABOUT BUSINESS MODELS 101

of revolutionary change in many industries. Some of the trends

identified in this book include the following:

• Vertically integrated firms are giving way to a more networked

approach. While this has been going on for years, the speed
of value chain destruction may be increasing as new “layer
players” enter specialized niches. New start-ups can now more
easily gain access to manufacturing and technology specialists
across the globe. TOMS is an example of an orchestrator firm
with far-flung operations.
• The influence of the Internet may have begun with Amazon,
but it is still leading to the growth and eruption of new busi-
ness models today. The ease through which the Internet,
combined with mailing or streaming technologies, can get
goods or services to people in remote locations is leading to
models that provide new value to customers who could not
get access in the past. This ranges from transportation to
dresses. In addition, companies that got started online,
such as Rent the Runway, are moving strategically to add
typical brick-and-mortar facilities in a more blended
approach.
• Customer cocreation is helping companies to rethink their
understanding of value and to realize how much they can
gain by considering customers as part of their business
models.5 Rent the Runway has done an excellent job, not
only enrolling customers as members, but also enlisting the
customers in the actual selling of their products.
• Collaborative consumption is increasingly invading new
industry space with both new corporate models and peer-to-
peer models emerging. A whole generation of customers may
be changing their attitudes about buying goods versus renting
them when needed.
• Some attention should be paid to the question of when to
let a business model die. When is it time to reinvest the
assets in entirely new venues and to create entirely new
models?
102 BUSINESS MODEL DESIGN AND LEARNING

As far as possible, every business model should be designed to

evolve as managers and frontline workers learn new and better ways
of doing things. Hamel calls this a dynamic business model.6 In this
book, I have advocated that a learning and review process should
be built into every model as soon as a value exchange is established.
Including the customers in the model is a good step toward this end.
However, even more openness is essential for long-term sustainabil-
ity and renewal.

10. Always think strategically about your business model.

David Teece argues that business models are more generic than
business strategies. He says that you must couple strategy analy-
sis with business model analysis in order to protect the competi-
tive advantage you’ve gained from implementing your model.7
I agree. As I pointed out in Chapter 1, a business model is not
strategy, but it does reflect your strategy. You make strategic deci-
sions about your business model when you decide which cus-
tomers to target, and how to use your resources to generate an
advantage over competitors. However, once you have established
your model, it constrains your future strategic decisions. Netflix
learned this after investing heavily in the infrastructure needed
to deliver DVDs to customers’ mailboxes. This worked very well
until video streaming came available. Then it had to figure out
how to compete with new entrants who had much less expensive
resources and processes.
Strategic analysis is an essential step in designing a competitively
sustainable business model.8 Sustainability can only be achieved if
you are providing superior value to your customers. When you think
strategically about your business model, you are always focused on
ways to stay ahead of the competition. You must also consider ways
to stop them from replicating your model.
One key to avoiding replication is to ensure that the differ-
ent parts of your business model are working together well as a
system. Johnson, Christensen, and Kagerman say that it’s not the
individual resources and processes that make the difference but their
 TEN KEY IDEAS ABOUT BUSINESS MODELS 103

relationships to one another.9 You have to integrate your resources

and process in unique ways. And your decisions about how to do this
must meet the requirements laid out in your profit formula.
RTR is a good example of a business model in which the parts are
not only consistent, but are mutually reinforcing. The high-quality
dresses are purchased through partnerships with particular designers
based on customer feedback. A partnership with a dry cleaner is used
to manage the costs associated with storing and cleaning the dresses.
The website is used not only to rent the dresses, but also to elicit
communication from customers, who even provide photos showing
how great you can look for your next event. Data from the website
are continuously studied to evaluate which dresses are popular in
which markets.
Strategic thinking is the most important role of the top manage-
ment of any firm. And strategic thinking about your business model
is critical to your current and future success. In this short book, I have
provided three lenses that can help you to focus on all of the pieces
of the model and to identify or clarify the logic that brings them
together. You can use these lenses to design a new business model,
or to study your current business model in order to come up with
innovations and changes to serve your customers better than the
competition.
A business model is a way of making your strategic choices
explicit.10 It provides you with a framework for deciding what to do
and what not to do.11 Ultimately, it can guide you toward making
decisions that are unique and valuable, and that will lead you and
your firm to sustainable competitive advantage.
 APPENDIX A

Pricing Mechanisms
For the customer, the way the product is priced is a measure of its exchange
value. If a customer believes that the product’s benefits outweigh the sacri-
fices and the actual price, then he or she may purchase it. People tradition-
ally think of pricing mechanisms such as charging a premium price for a
differentiated product or service, charging a discounted price to attract
new customers (short term or long term), or other mechanisms such as
auctions, and so forth. However, the Internet and rapidly evolving tech-
nologies have brought with them a new wave of innovative pricing mecha-
nisms.
For many entrepreneurs, these innovative pricing mechanisms have
opened up many new profit opportunities, and they have created a more
effective way to ensure that both parties in the transaction are getting
what they want. They can communicate their product offering to a wider
audience and at a more effective price than in the past.
It goes without saying that pricing is a huge part of the offer, and a
poorly chosen pricing mechanism can hurt the offer. People often forget that
the word “price” is really a synonym for many words including rent, tuition,
fee, fare, rate, toll, premium, bribe, due, salary, commission, wage, and tax.
To help entrepreneurs understand different ways they can price their prod-
ucts to avoid making a mistake, I provide a list of popular and innovative
pricing mechanisms and include a brief explanation of how each one works:

• Premium Pricing. For differentiated products, or those that

provide high value, you can charge a relatively higher price.
Such high prices are charged for luxuries such as Mercedes
automobiles, Ritz Carlton hotels, and Cunard Cruises as well
as Godiva Chocolates and Grey Goose Vodka.
• Penetration Pricing. When new products are introduced
to the market, some may choose initially to set the price
106 APPENDIX A

artificially low in order to gain market share. Once this is

achieved, the price is often increased. This can be a good idea
if the value of the product or service increases as more users
subscribe.
• Economy Pricing. Unlike penetration pricing, here the
long-term strategy is to keep costs down for the long term and
establish a no-frills low price. The supermarkets often offer
economy brands for soups, spaghetti, and so forth. In this
case, low price is often the key differentiator.
• Product Line Pricing. When you have a range of products
or services, your pricing may reflect the benefits of parts of
the range. For example, with car washes: a basic wash could
be $5, a wash and wax $6, and the whole package for $8.
Product line pricing seldom reflects the cost of making the
product since it delivers a range of prices that a consumer
perceives as being fair incrementally—over the range.
• Freemium Pricing. With a Freemium model, you give away
the basic services of your product for a limited period or for a
limited number of services, and then charge a fee after so many
weeks, or for the more sophisticated part of your services.
The catch here is that the functionality of your service or
product must be high enough such that a certain proportion
of your users will absolutely want to pay for the extension and
maintenance of the extras. In other words, your service must
provide benefits that are perceived as indispensable for certain
customers upon them experiencing it. Dropbox is my favorite
example. Two GB of storage are absolutely free, but once you
become addicted, they are not enough.
• Dynamic Pricing. In the article “Online Dynamic Pricing:
Efficiency, Equity and the Future of E-Commerce,” the
authors claim that “dynamic pricing is merely a new version
of the age-old practice of price discrimination.”1 Price
discrimination is observable in many industries today, such
as discounts to senior citizens, charging high interest rates
to young buyers of automobiles, and different airline prices
depending on the time gap between purchasing a ticket and
 APPENDIX A 107

the actual flight. However, dynamic pricing has taken on a

new meaning with advancements in technology such as the
Internet. Online companies are no longer tied to “menu
prices” that affect many other institutions, and prices can be
changed by simply updating a web page. Also, the Internet
has made it possible to gather information on individual
customers’ preferences through cookies and other techniques
that allow online retailers to make suggestions tailored to
these preferences. Finally, these technologies have affected
the way consumers shop, making it much easier for them to
quickly compare prices against the prices of competing firms.
• Advertising vs. Pricing. Many firms allow advertising on
their websites using different forms of pricing. One form
is to charge companies a fee to advertise on a site for a
predetermined period of time. For example, $1000 gets you
1 month of banner ads. Next, websites such as Google and
Yahoo charge users to be a “sponsored ad” where a company
wishing to advertise shows up first when someone searches for
a certain category. Also, many websites, including Facebook,
have a form of advertising called pay-per-click advertising
where the person wishing to advertise buys a certain amount
of “clicks.” Finally, many advertisers are pushing for a
pricing structure where the price for advertising reflects the
effectiveness or results of using different ads. Because the
revenues are generated by the advertising fees, customers may
be given access to these sites for free. In some cases, customers
can choose to use a site free with ads or they can pay to view
the site with no advertisements.
• Paywalls. Magazines and newspapers are the most common
users of this type of pricing. The Internet led many
subscribers of traditional newspapers and magazines to cancel
their subscriptions and start viewing content online. Websites
and blogs such as the Huffington Post started offering similar
content for free, leaving traditional newspapers and magazines
struggling to keep up. Many newspapers started offering
content online, but could not find a way to earn a profit
108 APPENDIX A

because users were viewing the information for free. To solve

this problem, the paywall was developed. Typically, companies
utilizing a paywall allow users to view a small portion of their
content for free (similar to a freemium), but charge users to
get full access to the site. According to one article, more than
20 percent of newspapers will utilize paywalls “…by the end
of 2012.”2
• Pay-per-use Pricing. The most notable pay-per-use platform
today is Apple’s iTunes. Apple will let users of their program
listen to a portion of a song for free, but charge them a fee to
buy the full version of the song. Also, the online application
market for smartphones is adapting this type of pricing, where
users can often download a trial version of an application
for free, but users must pay to access the entire application.
Information technology in general seems to be moving in
the direction of pay-per-use pricing. An online article claims,
“Going forward, [Information technology] will be a service
paid for on a usage basis rather than an asset that you buy and
put inside your corporation.”3
• Yield Management Pricing. This type of pricing is typically
pursued by companies who are constrained by capacity or
timing who wish to maximize their revenues. For example,
hotel and airline companies often struggle to fill rooms or
seats during certain parts of the year, and simply do not have
enough rooms or seats during peak times of the year. This
pricing mechanism ensures that revenues are maximized
during both cycles, by lowering prices during slow times to
stimulate demand and fill rooms or seats, and raising prices
(often significantly) during peak times to optimize their
revenues.
• Fixed Cost Pricing (Sticky, menu). Although many firms
seem to be moving away from this type of pricing, it is still
important to note. Under this type of pricing, prices are often
fixed at a given level for different reasons. First, customers
often get used to prices charged by a firm and will respond
negatively to changes in price. Consumers get used to a price
 APPENDIX A 109

and firms find it hard to increase the price, even if economic

theory suggests they should. Next, it is often unreasonable for
a firm to change the price of a good or service because of the
associated costs of doing so. That is, a firm will incur costs of
printing new menus, and so forth, which makes prices sticky
in the short run.
• Auctions (Dutch, English, Sealed Bid, Second-Price).
Auctions are one of the oldest and most common pricing
mechanisms. Most people, however, do not realize there are
multiple types of auctions. Each one will be briefly discussed.
 English. Under this type of auction, an auctioneer begins
the bidding (often times at a predetermined reserved price
that must be met) and participants bid on the product.
The auctioneer continues to increase the bid price until no
one else is willing to bid on the product, at which time the
bidder with the highest price buys the product.
 Dutch. This type of auction begins with the auctioneer
starting out at a price that is higher than the product is
expected to sell for, then lowering the price in increments
until a bidder agrees to buy. This type of auction usually
takes very little time.
 Sealed Bid. This type of auction involves bidders putting
in a one-time bid in a sealed envelope. The bids are then
opened, and the highest bidder wins the bid.
 Second-Price Sealed Bid. Much like a sealed bid auction,
the winner is the one with the highest bid. However, they
pay the price offered by the second highest bidder. This
form of auction is fairly uncommon.
• Reverse Auction. This form of pricing typically occurs when
a buyer intends on purchasing a large amount of something
in the future. The buyer announces a plan to make a purchase
at some specific point in the future (6 months is typical),
and the competing firms put together their best bid, which
they place on the specified date. The end result is that the
buyer typically receives a huge price discount as a result of
the bidding, often at the expense of the bidder. This type of
110 APPENDIX A

pricing can put huge pressures on suppliers and small firms,

who are afraid they will bid too low and not maximize their
profits on the sale, or overbid and lose to a competing firm.
• Negotiation. Everyone at some point takes part in a
negotiation. While more than just prices can be negotiated,
this form of pricing involves both sides (the buyer and the
seller) trying to convince the other to either raise or lower
the price. Websites, such as Craigslist, bring the art of
negotiation into the Internet age. Craigslist allows for users to
post an online classified ad for products and services, which
often include a price that the seller is looking to receive.
Alternatively, buyers can also post ads indicating that they are
looking to purchase something. Craigslist does not take part
in the actual exchange, however, and the two parties involved
in the exchange often negotiate over the asked price from the
classified.
• Cost-Plus Pricing. With this form of pricing, a firm
determines the total cost of producing a product or service,
and then marks the price up in order to achieve a certain
profit margin. For example, if the total cost to produce a
beer is $1, a firm can price the product at $1 plus an extra
20 percent (for a total of $1.20) if they wish to earn a profit
of 20 percent per unit.
• Target Return Pricing. This type of pricing helps investors
determine what price they should charge in order to recoup
their investment (plus an additional amount if they desire).
For instance, if a group of investors wishes to recoup their
investment of $100,000 in a beer company plus an additional
20 percent, and 100,000 units of beer are expected to be sold
over the next year, then at the price of $1.20 per unit the
investors can meet their target return.
• Breakeven Pricing. Similar to target return pricing, but
instead of pricing at a point where the firm will earn a certain
target return, the firm will set the price at a level that will help
the firm break even. In the beer example, if 100,000 units are
expected to be sold, price the product at $1.
 APPENDIX A 111

• Value-Based Pricing. Pricing a product or service based on

the value that a user of the product or service will get out
of it. For example, installing solar panels on one’s roof will
save them an average of $20,000 over 5 years. Selling the
product for $1000 would be of great value to the consumer,
and charging an even higher price would most likely be
acceptable. However, the person purchasing the product must
perceive that a product will provide a certain amount of value
(whether it will or not) for this to work.
• Going Rate Pricing. Simply charge the amount that other
firms are charging for a similar product. For example, if a firm
sells coffee in a small town, this firm will simply price their
coffee at the same price as similar firms in the area.
• Captive Product Pricing. This form of pricing involves a firm
selling you something at a steep discount in order to captivate
you into purchasing something in the future. For example,
Dell and other computer manufacturers will practically give
you a printer with the purchase of a computer. They do this
because they know that you will have to buy specifically
designed ink cartridges for the printer at a steep markup in
the future from them, making it very easy for them to recoup
their investment.
• Promotional Pricing.
 Loss-Leader Pricing. Similar to penetration pricing. This
usually occurs when a retailer sells a particular product
at a loss in order to get people into the store. Although
the store may lose money on one item, customers will
hopefully buy more.
 Special Event Pricing. This form of pricing occurs when
a firm offers a discount (or sometimes charges a premium)
for a special occasion. For example, a baseball team might
give a discount to veterans on Veterans Day.
 Cash Rebates. This occurs when a firm offers the buyer of a
product a small reimbursement for purchasing the product.
They often do so knowing that few consumers will actually
go through the trouble of redeeming the reimbursement.
112 APPENDIX A

 Coupons. A form of advertising in which a consumer

receives a discount for presenting a coupon that assures a
discount for the product or service.
 Warranties. To convince consumers that a product or
service will meet their expectations, companies often offer
warranties that promise a refund to a defunct or unfulfilled
product or service. Often companies will charge the buyer
of a product for a warranty.
• Channel Pricing. This is best illustrated through an example.
Consider how much you typically pay for a softdrink. It is
likely that there is a discrepancy between the price you pay
at the grocery store, a vending machine, or a restaurant. This
discrepancy can often be very large. For example, a beer at an
NFL football game can be upwards of $9.
• Penalties. This form of pricing is usually in addition to
another form of pricing. It punishes customers for not
holding up their end of the deal. For example, cell phone
companies will often charge a penalty for going over your
predetermined amount of minutes or data. Also, phone
companies will charge you for canceling your contract. Banks
often charge penalties for going over your limit in the form of
overdraft fees.
• Framing.
 Pennies a day. This type of pricing strategy involves
putting the price of your product or service into a daily
increment. For example, nonprofit organizations often use
this strategy to convince people to donate to their cause.
Asking for $50 dollars a year to support a child that the
person making the donation most likely will never see
sounds like a lot, but when these organizations say that you
can feed a child for only ten cents a day, it seems reasonable
to many people.
 Reverse Strategy. By contrast, many nonprofits use the
opposite of the pennies-a-day strategy to convince people not
to do something. A good example of this is telling consumers
how much they can save per year by not smoking.
 APPENDIX A 113

 Odd and Even Pricing. Some merchants will price

a product at 9.99 vs. 10.00 because they believe that
customers will perceive it as significantly lower.

There are many more forms of pricing mechanisms, and with the
advent of new technologies there will certainly be more to come, but this
should give you some ideas about how to price your product or service.
 APPENDIX B

Online Marketplaces
The Internet has brought with it a completely new way of doing busi-
ness for many entrepreneurs as well as already established businesses. It
is no longer necessary for a business to have a brick-and-mortar store,
mail catalogue, or even a company website to get products to customers.
For example, there are thousands of businesses that use Amazon, Ebay,
Buy.com, Craigslist, or other online marketplaces to communicate and
negotiate with customers. Before these online marketplaces existed,
many entrepreneurs did not pursue potentially profitable ideas because
of the difficulty of communicating a product offering and getting that
product to the end customer. I would venture to say that a majority of
people who read this book have purchased something through one of
these marketplaces. To give you a better understanding of how many
popular online marketplaces work, and how you can use these market-
places, I have listed 20 online sites here. These are culled from an excel-
lent list called the “28 Leading Online Marketplaces” from the website
100auctionsites.com.1

1. Amazon Marketplace—Amazon Marketplace is a fixed-price online

market that allows sellers to offer their goods alongside Amazon’s offer-
ings. Buyers are able to purchase new or secondhand items sold directly
by a third party through the Amazon Marketplace. Sellers are charged a
small commission based on the sale price, a transaction fee, and a vari-
able closing fee.
2. Buy.com—Buy.com offers buyers a wide variety of products and reason-
able prices on books, toys, jewelry, electronics, pet supplies, and many
other items. It charges sellers a commission ranging from 8 percent to
116 APPENDIX B

15 percent depending on the category and ensures good traffic for all
items since it has become a popular online retailer.
3. Etsy.com—This market is for handmade and one of a kind
objects including handmade jewelry, vintage clothing, fine artwork,
and crafts of all kinds. Etsy serves its clients by giving them publicity
and accessibility to customers looking for one of a kind goods.
4. Half.ebay.com—Half.ebay.com is a popular marketplace for buyers
and sellers alike. The site offers a broad selection of books, music,
games, and movies. It is especially popular with students who use it
for getting discounts on textbooks. The site charges a small commis-
sion to sellers.
5. Ecrater.com—Ecrater.com is a free web store builder and free
online marketplace. This website does not charge a commission on
sales. Products are posted to Google Product Search for increased
trafficking.
6. ioffer.com—ioffer.com is an online community that allows
you to buy, sell, and trade by negotiating. Its ability to simulate
real-life transactions makes it a useful and helpful site. The site
offers over 35 million items to negotiate on. The site has no listing
fees.
7. Bonanzle.com—Bonanzle.com is an online market that is similar to
Ecrater and Etsy. Its slogan is “Find Everything but the Ordinary,”
and it offers products ranging from artwork to antiques, coins and
paper money, dolls, pottery and glass, as well as other craft-oriented
items. All of the items on Bonanzle.com are unique in some way.
Sellers can benefit from Bonanzla’s featured items, as well as the
setup of their own online stores.
8. Newegg Marketplace—Newegg Marketplace is the marketplace
associated with Newegg, an electronics retailer. This site receives
millions of visitors each month and includes jewelry, sporting
goods, pet supplies, fragrances, and other assorted categories of
items.
9. MadeItMyself.com—This website lists handmade items rom bird-
baths to sachets. The many categories of items change frequently and
include many unique offerings.
 APPENDIX B 117

10. ArtFire.com—This site focuses on handmade items from indi-

vidual artists. The categories include handmade, design, supplies,
vintage, fine art, and media. Within those categories are even
more subcategories to help buyers find what they are looking for.
The items vary in style, material, color, and craft.
11. Rubylane.com—This marketplace claims its “Ruby Lane Advan-
tage” is based on quality, security, and excellent customer service. It
includes items related to fine art, antiques, and collectibles as well as
unique jewelry pieces.
12. Tias.com—Tias.com also offers antiques and collectibles on the
web. Most of the site’s sellers are authentic antiques dealers who run
shops of their own, and use Tias as an additional outlet to reach over
200,000 customers a day.
13. Goantiques.com—Goantiques.com brings together antique retail-
ers and collectors. Goantiques.com has over 1,000 dealers from 31
countries who contribute a wide array of products to its Virtual
Warehouse.
14. Blujay.com—Blujay.com is another online marketplace that is free
to use. The site uses PayPal and Google Checkout to handle its trans-
actions, and also posts listings to Google’s Product service, thereby
increasing customer traffic.
15. Cyberattic.com—Cyberattic.com is a marketplace for both buyers
and sellers of antiques, home decorating items, and collectibles.
Categories include children’s collectibles, home decorating, silver,
glass, memorabilia, and ephemera.
16. Trocadero.com—The site focuses on buying and selling art,
antiques, home décor, and other collectibles. It is known for offering
rare paintings, estate jewelry, and other popular collectibles. Fees
range from $45 to $70 dollars a month for sellers and provide an
array of promotional services.
17. Atomicmall.com—Atomicmall.com is a marketplace with spaces
dedicated to sellers and buyers, making it easy to use and navigate.
Sellers can join for free and are charged a small commission on
sales. Sellers are also able to import offsite auctions (from say, your
eBay listing), and utilize Paypal, Google Check Out, and Amazon
118 APPENDIX B

payment methods. Buyers can chat with Sellers in real time, and use
one cart for multiple stores.
18. Collect.com—This marketplace is aimed at different kinds of collec-
tors. It has a variety of categories, such as automotive, ceramic and
glass, furnishings and fine art, jewelry and timepieces, collectibles,
numismatics, outdoors, guns and knives, comics, music and movies,
sports, and toys.
19. Wigix.com—Wigix.com is an online marketplace for buyers
and sellers interested in electronics. It promises that you will
“never overpay again,” and provides a live pricing history that
details how much the previous buyer spent on the product
you’re viewing. The structured catalogue makes it easy to find
specific products and the Premier Product Destination cata-
logue includes user manuals, videos, reviews, blogs, and more to
help customers make decisions. There are minimal “final value”
fees for items above $25.
20. Pricegrabber.com—Pricegrabber.com is a service that allows
sellers to list and sell merchandise easily and conveniently
whether or not they have their own websites, and provides safe
transactions for buyers as well. If you mainly want to drive buyers
to your own website, you can select the pay per click method of
payment (where you pay each time someone clicks on your ad). If
you don’t have a website, you can choose to use the Pricegrabber
site to manage your transactions and then you will pay a per-
centage of your revenues upon each actual purchase. Pricegrabber
includes many different categories from computers to appliances
and furniture. The site attracts over 26 million visitors each
month.

Once again, this is by no means a comprehensive list, and the number

of online marketplaces available will undoubtedly continue to grow. They
will be more tailored to specific products or market segments, meaning
that entrepreneurs will have to do their homework to select the right
online marketplace to utilize. Also, it might not be a bad idea to spread a
business out among a few different online marketplaces to make sure you
are reaching everyone you wish to reach.
 Notes
Chapter 1
1. Stähler (2012).
2. Stähler (2012).
3. Stähler (2012).
4. Teece (2010).
5. Zott and Amit (2008).
6. Teece (2007).
7. Magretta (2002).
8. Linder and Cantrell (2000).
9. Teece (2010), p. 179.
10. Morris, Schindehutte, and Allen (2005).
11. Morris, Schindehutte, and Allen (2005).
12. Priem (2007).
13. Teece (2010).
14. Teece (2010).
15. Porter (1996).
16. Gray (2008).
17. Casadesus-Masanell and Ricart (2011).
18. Shafer, Smith, and Linder (2005).
19. Shafer, Smith, and Linder (2005).
20. Teece (2010), p. 182.
21. Teece (2010), p. 189.
22. Holloway and Sebastiao (2010).
23. Holloway and Sebastiao (2010).
24. Johnson, Christensen, and Kagermann (2008).
25. Sarasvathy and Dew (2005).

Chapter 2
1. Handfield (2006).
2. Handfield (2006).
3. Magretta (2002).
4. Timmers (1998).
5. Rappa (2001).
6. Teece (2010), p. 174.
7. Wong (2011).
8. Linder and Cantrell (2000).
120 NOTES

9. Sheahan (2012).
10. Zott, Amit, and Massa (2011).
11. Johnson, Christensen, and Kagerman (2008).
12. Johnson (2010).
13. Johnson, Christensen, and Kagerman (2008).
14. Morris, Schindehutte, and Allen (2005).
15. Ple, Lecocq, and Angot (2008).
16. Ple, Lecocq, and Angot (2008).
17. Chesbrough (2006).
18. Groonros and Rivald (2011).
19. Priem (2007).
20. Newton (2011).
21. Morris, Schindehutte, and Allen (2005).
22. Morris, Schindehutte, and Allen (2005).
23. Kim and Mauborgne (2005).
24. Priem (2007).
25. Blank and Dorf (2012).
26. Magretta (2002).
27. Shafer, Smith, and Linder (2005).

Chapter 3
1. Lai (1995).
2. Sundhar (2010).
3. Sundhar (2010).
4. Sundhar (2010).
5. Bomgar.com (2012).
6. Wong (2008).
7. Wong (2008).
8. Wong (2008).
9. Wong (2008).
10. Wong (2008).
11. Bettman (1979).
12. Woodruff (1997).
13. Woodruff (1997).
14. Huffman, Ratneshwar, and Mick (2000).
15. Rokeach (1968).
16. Rokeach (1968).
17. Huffman, Ratneshwar, and Mick (2000).
18. Marcus and Ruvolo (1989).
19. Marcus and Ruvolo (1989).
20. http://www.dapplebaby.com/our-story.html retrieved October 1, 2012.
21. Johnson, Christensen, and Hagerman (2008), p. 52.
22. Johnson, Christensen, and Kagerman (2008).
 NOTES 121

23. Nobel (2011).

24. Nobel (2011).
25. Nobel (2011).
26. Christopher et al. (1991).
27. Woodruff (1997).
28. Day and Crask (2000).
29. Day and Crask (2000).
30. Woodruff and Gardial (1996).
31. Zeithaml (1988).
32. Zeithaml (1987).
33. Lai (1995).
34. Rivald and Gronroos (1996).
35. Priem (2007).
36. Ratneshwar, Mick, and Huffman (2000).

Chapter 4
1. Nalley (2012).
2. Johnson, Christensen, and Kagerman (2008).
3. Morris, Schindehutte, and Allen (2008).
4. Magretta (2002).
5. Johnson, Christensen, and Kagerman (2008).
6. Johnson, Christensen, and Kagerman (2008).
7. MFJ Enterprises Website (2012).
8. Newton (2011).
9. Newton (2011), p. 21.
10. Newton (2011), p. 22.
11. Blank and Dorf (2012).
12. Schweizer (2005).
13. Schweizer (2005).

Chapter 5
1. Johnson, Christensen, and Kagermann (2008), p. 52.
2. Bansal (2012).
3. Mycoskie (2011).
4. Mycoskie (2011).
5. Mycoskie (2011).
6. Mycoskie (2011).
7. Murray and Wang (2011).
8. www.toms.com
9. Vitella (2011).
10. Schwartz (2011).
11. Cone Cause Evolution Study (2010).
122 NOTES

12. Teece (2010), p. 188.

13. Bansal (2012).
14. Schweizer (2005).
15. Schweizer (2005).
16. Schweizer (2005).
17. Shah (2011).
18. Poulos (2012).
19. Karmini and Wright (2011).
20. Mainwaring (2010).
21. www.toms.com
22. Aakers (2012).
23. Aaker (2012).
24. Aaker (2012).
25. Q&A: Blake Mycoskie (2011).
26. Teece (2010).
27. Reich (2012).

Chapter 6
1. Ho (2006).
2. Blau (1964).
3. Liedtke (2011).
4. Liedtke (2012).
5. Hamel (2000).
6. Shafer, Smith and Linder (2005).
7. Shafer, Smith and Linder (2005).
8. Cheredar (2011).
9. Ludwig (2011)
10. Wilson and Crawford (2012).
11. Hoffman (2009).
12. Chesbrough (2010).
13. Gustin (2011).
14. Gustin (2011).
15. Wingfield and Stelter (2011).
16. Wingfield and Stelter (2011).
17. Wingfield and Stelter (2011).
18. Ple, Lecocq and Angot (2010).
19. Ple, Lecocq and Angot (2012).

Chapter 7
1. Orley (2012).
2. Fairchild (2012).
3. Levinson (2012).
 NOTES 123

4. Orley (2012).
5. Binkley (2011).
6. Hyman (2012).
7. Chatzki (2010).
8. Orley (2012).
9. Levinson (2012).
10. Levinson (2012).
11. Levinson (2012).
12. Orley (2012).
13. Chatzki (2010).
14. Lapowski (2012).
15. Lapowski (2012).
16. Binkley (2011).
17. Wahba (2011).
18. Roush (2010).
19. Ebbert (2012).
20. Binkley (2011).
21. Binkley (2011).
22. Binkley (2011).
23. Binkley (2011).
24. Orley (2012).
25. Wortham (2009).
26. Fleiss (2012).
27. Fleiss (2012).
28. Ballard (2012).
29. Del Castillo (2012).
30. Tungez (2011).
31. Tungez (2011).
32. Tungez (2011).
33. Walsh (2011).
34. Fairchild (2012).
35. Tungez (2011).
36. Botsman and Rogers (2010).
37. Levinson (2012).

Chapter 8
1. Ashkenas (2012).
2. Teece (2010).
3. Morris, Schindehutte, and Allen (2005).
4. Morris, Schindehutte, and Allen (2005).
5. Johnson, Christensen, and Kagerman (2008).
6. J.C. Penney.com (2012).
124 NOTES

7. Tibbetts (1999).
8. Poggi (2012).
9. Lewis (2011).
10. Lewis (2011).
11. Lewis (2011).
12. Department stores Industry Report (2012).
13. Berk (2012).
14. Lauchheimer (2012).
15. Lauchheimer (2012).
16. Brugger (2012).
17. Chernev (2012).
18. Gallo (2012).
19. Gallo (2012).
20. Berk (2012).
21. Brown (2012).
22. Berk (2012).
23. Chernev (2012).
24. Moore (2012).
25. Coleman-Lochner (2012).
26. Brown (2012).
27. Brown (2012).
28. Loeb (2012).
29. McIntyre (2012).
30. Ries (2012).
31. Kalb (2012).
32. Bhasin (2012).
33. Askenas (2012).
34. Chernev (2012).
35. Chernev (2012).

Chapter 9
1. Zott and Amit (2008).
2. Teece (2010), p. 190.
3. Johnson, Christensen, and Kagerman (2008).
4. Chesbrough (2010).
5. Gronroos and Ravald (2011).
6. Hamel (2000).
7. Teece (2010).
8. Teece (2010).
9. Johnson, Christensen, and Kagerman (2008).
 NOTES 125

10. Morris, Schindehutte, and Allen (2005).

11. Morris, Schindehutte, and Allen (2005).

Appendix A
1. Weiss and Mehrotra (2001).
2. Lang (2012).
3. Junnarkar (1999).

Appendix B
1. 100 Auction Sites: 28 Leading Online Marketplaces. http://www.100auctionsites
.com/online-marketplaces.php.
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 Index

A Business models. See also specific

Adaptive business model business models
customer and firm relationship, 5–6 adaptability, 10
customer attitudes and behaviors, 23 agreement, 2
foundation and differentiators, 22 business-model-in-use, 94
Rent the Runway (RTR), 73–74 business outsourcing, 13
revenues, 23 collaborative consumption, 101
TOMS shoes, 58–59 commodity, 2
value exchange relationship, 22 conceptual tool, 93–94
costs and benefits, 97–98
B customers, 17
Bomgar box cocreation, 101
benefits and sacrifices goals and aspirations, 97
Bomgar’s multiplatform relationship, 2
capability, 35 value proposition, 3, 99–100
costs, 34 definition, 3, 15
deliverables, 36–37 deliverables, 98–99
emotional outcomes, 33 dynamic, 102
levels of drivers, 35 e-business, 14
physical outcomes, 33 elements, 16
social outcomes, 33 entrepreneur, 16–17
trade-offs, 34 feasibility, 10
use-value, 33 firm and customers relationship, 17
Bomgar, Joel Internet, 101
appliance-based products, 28 lenses, 95–96
HMHP Company, 28–29 adaptive business model (see
part-time IT support Adaptive business model)
representative, 27 differentiated business model
remote-administration tool, 29 (see Differentiated
software promotion, 28 business model)
customer value hierarchy foundation level business model
economic and social goals, 30 (see Foundation business
long-term goals and model)
purposes, 30–31 implementation, 24–25
problem solving, 31–33 partnerships, 103
product costs and benefits, 29 problem solving, 96–97
Woodruff ’s hierarchy, 29–30 reinvestment, 101
136 INDEX

Ron Ashkenas’s blog, 79 leadership and vision, 70–71

strategic analysis, 102 profit formula, 72
strategic circumstances, 80 sustainable competitive
strategic thinking, 103 advantage, 20
vs. strategy, 6–8 TOMS shoes
sustainability, 10, 102 customer value proposition, 53
trade-offs, 98 firm leadership and
value exchange relationship, 8–9 logic, 53–54
vertically integrated firms, 101 key resources and
viability, 10, 79 processes, 51–52
Business outsourcing, 13 profit margin, 52–53
uniqueness, 5
C Dynamic business model, 102
Crowd-sourcing algorithm, 65
Customer value proposition, 3, 5, 16, 18 E
Ham radio company, e-Business models, 14
MFJ Enterprises, 43
J.C. Penney store, 87 F
Rent the Runway (RTR), 72–73 Foundation business model
TOMS shoes, 53 customer value proposition, 18
definition, 5
D ham radio company (see Ham radio
Differentiated business model company, MFJ Enterprises)
Blue Ocean strategy, 22 key resources and processes, 18–19
business model foundation profit formula, 19–20
separation, 21 resources and develop
customer expectation, 22 processes, 17
customer value proposition, 5
ham radio company, H
MFJ Enterprises Ham radio company,
company website, 46 MFJ Enterprises
hamfests, 46 differentiators
innovation capabilities, 45 company website, 46
integrated business hamfests, 46
models, 46–47 innovation capabilities, 45
value proposition, 46 integrated business
J.C. Penney store models, 46–47
customer value proposition, 87 value proposition, 46
key processes, 86–87 foundation business model
key resources, 85–86 customer value proposition, 43
leadership and vision, 84–85 elements, 40–41
profit margin, 87 feasibility, 43–44
Netflix, value exchange firm aspirations and goals, 41
agreement, 64–65 hypothesis testing, 43
Rent the Runway (RTR) key processes, 42
customer value proposition, 72–73 key resources, 42
key processes, 71–72 profit formula, 42–43
key resources, 71 viability, 44–45
 INDEX 137

Jue, Martin ham radio company,

ham number, K5FLU, 39 MFJ Enterprises, 42
hobby, 46 J.C. Penney store, 85–86
Morse code, 39 Netflix, value exchange
personality and background, 46 agreement, 63
vertical integration, 47 Rent the Runway (RTR), 71
TOMS shoes, 51–52
J
J.C. Penney store N
background, 81 Netflix, value exchange agreement
department stores rise and fall logic and internal consistency, 62
competitors, 82 relationship, 61–62
discounting techniques, 83 reputation and credibility, 63
mass merchants, 83 streaming business, 62
online stores, 83 unlimited DVDs by mail, 61–62
palaces of consumption, 82 value network, 62
T.J. Maxx and Ross Stores, 83 value propositions, 63
Walmart, 83–84 winning model vs. changes
differentiated business model crowd-sourcing algorithm, 65
customer value proposition, 87 customer decisions, 66
key processes, 86–87 differentiated business model
key resources, 85–86 lens, 64–65
leadership and vision, 84–85 film library, 63
profit margin, 87 key processes, 63
model changes key resources, 63
business opportunities, 91 profit margin, 64
competitor disruption, 90 social community, 66
consumers education, 92 video streaming, 64
fair-and-square pricing policy, 91 Nike company, 55
focused value proposition, 90
fundamental change, 91 M
hypothesis testing, 91 MFJ Enterprises. See Ham radio
negative influences, 90 company, MFJ Enterprises
staffing levels, 90
store brands, 90 O
strategic repositioning, 84 Orchestrator model, 54–56
value exchange agreement, 88–89
P
K Philanthropic Capitalism, 59
Key processes, 16, 18–19 Profit formula, 16, 19–20
ham radio company, ham radio company,
MFJ Enterprises, 42 MFJ Enterprises, 42–43
J.C. Penney store, 86–87 Rent the Runway (RTR), 72
Netflix, value exchange Profit margin
agreement, 63 J.C. Penney store, 87
Rent the Runway (RTR), 71–72 Netflix, value exchange
TOMS shoes, 51–52 agreement, 64
Key resources, 16, 18–19 TOMS shoes, 52–53
138 INDEX

R customer value proposition, 53

Rent the Runway (RTR) firm leadership and logic, 53–54
adaptive business key resources and
model, 73–74 processes, 51–52
bridal wear, 78 profit margin, 52–53
collaborative consumption, 76–77 Mycoskie, Blake
competitors, 78 alpargata, 50
customer behavior, 69 The Amazing Race, 50
customer feedback, 77 buy-one give-one business
customer goals and aspirations, 73 model, 49
customer relationships, 74–75 company history, 51
differentiated business model donation relied
customer value proposition, 72–73 organization, 50
key processes, 71–72 other business, 50
key resources, 71 orchestrator model, 54–56
leadership and vision, 70–71 Philanthropic Capitalism, 59
profit formula, 72 sustainability, 56–57
emotional connection, 73
free membership website, 69 V
learning and adaptability, 77 Value exchange relationship, 8–9
social network, 77 Value exchange agreement
socioeconomic groundswell, 77 J.C. Penney store, 88–89
sustainability, 73–74 Netflix (see Netflix, value exchange
agreement)
T
TOMS shoes W
adaptive business model, 58–59 Woodruff ’s customer value
differentiated business model hierarchy, 29–30
 OTHER TITLES IN THE STRATEGIC MANAGEMENT
COLLECTION
William Q. Judge, Old Dominion University, Collection Editor

• Grow by Focusing on What Matters: Competitive Strategy in 3-Circles

by Joel E. Urbany and James H. Davis
• Building Organizational Capacity for Change: The Leader’s New Mandate
by William Q. Judge
• Business Intelligence: Making Decisions Through Data Analytics by Jerzy Surma
• Designing the Networked Organization by Ken Everett
• Successful Organizational Transformation: The Five Critical Elements
by Marvin Washington, Stephen Hacker, and Marla Hacker
• Top Management Teams: How to Be Effective Inside and Outside the Boardroom
by Annaloes M.L. Raes
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• A Stakeholder Approach to Issues Management by Robert Boutilier
• The Strategic Management of Higher Education Institutions: Serving Students as
Customers for Institutional Growth by Hamid Kazeroony
• Managing for Ethical-Organizational Integrity: Principles and Processes for Promoting
Good, Right, and Virtuous Conduct by Abe Zakhem
• Corporate Bankruptcy Fundamental Principles and Processes by William J. Donoher
• Learning Organizations: Turning Knowledge into Action by Marcus Goncalves
• Moral Leadership: A Transformative Model for Tomorrow’s Leaders by Cam Caldwell
• Knowledge Management: The Death of Wisdom: Why Our Companies Have Lost It—and
How They Can Get It Back by Arnold Kransdorff
• Intellectual Property in the Managerial Portfolio: Its Creation, Development, and
Protection by Thomas O’Connor
• Strategy and Training: Making Skills a Competitive Advantage by Philippe Korda
• Business Models and Strategic Management: A New Integration by Francine Newth
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 Business Model Design and Learning
A Strategic Guide
Dr. Barbara Spencer
So many of us have asked ourselves—what’s a business model? What’s a
good business model? This book has all the answers—it explains what a
business model is, what you have to do to get one, and what to do about
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they don’t get the value they are seeking, you won’t either.

Dr. Barbara Spencer is a professor of management for the College of

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in the MBA program and coaches students as they provide consulting
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