We’ve been following a theme on the blog lately on business models and innovation. Last week I wrote about the connection between business model innovation and strategy and Tim wrote a really nice case study of business model innovation in the electric car industry. In this post, I’ll discuss some key ideas about business models from Mark Johnson and Clay Christensen and then show how these play out in a case study of a green-tech company called Papyrus, which developed a method for turning banana trees into paper.

According to Johnson and Christensen, good business models have three key elements that must be logically consistent with each other. These are:

*Customer value proposition
*Profit formula
*Key resources and processes

Using the German white goods manufacturer Miele as an example, the value proposition is the best performing products in their categories enabling margin to be driven by price premiums and the key resources are people and processes that underwrite their R&D and manufacturing. See if you can go through a similar exercise with businesses that you like, or your own organization.

If you have read my strategy post from last week you should start to see similarities with the strategy diamond. Johnson and Christensen’s elements of business models are just a truncated version of the diamond. Once again, the old logic of strategic fit and discipline rises to the surface. An technological invention is part of the third category of resources and processes but there is a big gap between and invention and a complete business model.

Papyrus is small company listed on the Australian stock exchange. I have been using it as a teaching case over the years because it is a straightforward business that is easy for students to understand and analyze. The corporate video is a good five minute introduction to the company.

When the company listed in 2005 the prospectus told a compelling investment story. This was a technically elegant solution to a heavily polluting and resource-intensive industry. What’s more, energy and water consumption was a fraction of traditional paper processing using wood chips and pulp mills. The part where the story got a bit fuzzy was the business model. While production cost comparisons were made with pulp mills, the main suggestion was that someone would license the technology and sort out the business model for them.

Going for the licensing option is a preferred route for many tech companies because it puts of the hard work of building the business model to one side. However, I can think of at least five examples of where the buyer didn’t materialize and the company had to start committing to a strategy that included a viable business model. This is exactly what happened to Papyrus.

In the float prospectus, Papyrus looked like it was based on a cost leadership model. Low production costs would enable them to compete with paper and cardboard. However, the business model didn’t have a customer value proposition because they weren’t clear about who the customer was. If they were licensing, then the customer could be a paper manufacturer looking for environmentally friendly processes to experiment with. If they were going to produce the banana paper then the customer was the paper distribution companies. The following diagram compares Papyrus with traditional manufacturers (source: www.papyrusaustralia.com.au)

The problem was that these distribution companies have evolved to operate at scale with low margins in the paper business. Papyrus’s decentralized production model of producing paper at banana plantation meant that coordinating production at scale was going to be a problem. Slowly accelerating production by selling machines to more plantations just wasn’t going to work. Essentially, the key technical resource of papyrus wasn’t valuable to the bulk paper industry.

Back in 2007, I used Papyrus as a strategy case in my MBA class and the chairman, Dr. David Wyatt, kindly gave a guest lecture on the company. One of my best students, who now works in strategy consulting, noticed that timber veneers had some of the highest margins in the timber products industry and showed how a business model of producing veneer could work. This was a good solution because it fitted with the small and flexible nature of production with good margins. With a timber veneer company as a customer, the value proposition was quality sheets of fiber that came from a renewable resource. Instead of ending up as bulk paper, the product would be onsold to custom boat builders and prestige car companies. As you can see in this news report, they are now manufacturing veneer and selling it. The business logic of the company is now starting to make sense.

I think that there are two key lessons from the case:

1. Focusing on the technology and hoping someone else will sort out the business model rarely works.

2. It can take time to find the right model, but it can be the secret to unlocking the value of the technology.