New technologies require new business models to succeed.

I can’t prove this yet, but the more I study the innovation process, the more convinced I am that this is true.  If you have an innovative new idea (and this can be a product, a service or a new way of doing things), if you are going to replace something directly, you need to perform at least 10X better than the incumbent.  That’s not impossible, but that’s a pretty big jump.

It’s much better to come up with something interesting, and then innovate the business model.

I was talking about this yesterday with my colleague Jeffrey Babin.  He agreed with me, and he pointed me to one of the IBM CEO Reports that addresses this issue.  There are two key pieces of data in it.  The first shows how firms distribute their innovation efforts:

It shows that while most organisations put some effort into innovating across the board, business model innovation gets the least attention.  But look at the impact of the three different types of innovation on the bottom line:

This shows the effect that innovating has on profits compared to firms in the same industry that don’t innovate.  As Jeffrey said, product and service innovation is baseline stuff – you have to do it to stay in the game.  The firms that primarily tried process innovation were actually worse off!  And those that undertook business model innovation had a 5% higher compound annual growth rate over five years.

5% higher compound annual growth – the argument should be settled right there – you should probably stop reading right now and immediately start innovating your business model if you aren’t already.

In case you’re still reading, here are a few more thoughts.

If you’re in a startup, innovating the business model is a bit easier than if you’re in a large firm.  The whole lean startup approach is basically built on the idea that the main objective of a startup is to build a scalable business modle.  This is a big part of the reason that lean startups turn into innovative firms.

Building business model innovation capabilities is a bit more challenging if you are a larger firm.  Paul Hobcraft recently discussed some of the issues here.  The problem is that you will be competing against startups that are innovating your industry’s business model – if not right now, then in the future.  So you need to have this skill.  And also, it leads to 5% higher CAGR!

Managing multiple business models within one firm is challenging.  However, you can see the payoff.  And some very large firms have done this very successfully.  I’ve spoken before about how Dow Corning did this with Xiameter, and how Hindustan Unilever did this with their Shakti initiative.

So it’s not impossible, it’s just hard.  And that’s exactly why it pays off – there’s no reward for solving easy problems.

I was talking late last year with the Chief Operating Officer from a company I’ve worked with for a while.  They are just now starting to benefit from a business model innovation effort that they started nearly three years ago.  They are a market-leading firm, but they have been facing increased competition recently as others have entered the market.

First, I asked him how long it took his competitors to copy a new product or service.  He said that it used to take 18 months, but now the time was down to 6 months.  Next, I asked him what he thought the outcome of their business model innovation would be.  He said “Well, it will take our competitors a year or two just to figure out what we’ve done and how we’ve done it.”  I pointed out that even then, they’ll have to go through a 2-3 year transition just like he did if they want to copy the business model.

Think about that for a second – product innovation gives them a 6 month competitive advantage, but the advantage from business model innovation is a few years.

Rita Gunther McGrath argues convincingly that competitive advantages have increasingly limited lifespans.  I agree with her.  Business model innovation is one of the best ways to respond to this.  It leads to higher growth, bigger profits, and higher chances of sticking around for a while.

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