Playing To Win

Where’s the Business Model in Playing to Win?

It’s a Part of All the Boxes

I am frequently asked the question: Where is the business model in the Playing to Win Strategy Choice Cascade? Shouldn’t there be a sixth box for business model? I get the question sufficiently often that I decided to do my 25th Playing to Win/Practitioner Insights (PTW/PI) on Where’s the Business Model in Playing to Win? (Links for the rest of the PTW/PI series can be found here.)

The Business Model

Business model takes on a mythical aura for many. When entrepreneurs get asked about their business model, the desired response is something that will make it clear it is headed for the stars. It is going to be the Airbnb of x or the Warby Parker of y. Our ‘business model’ is that we’ll charge $1.50/order to the shoe company to which we send a shoe-buyer that comes to our shoe-buying aggregation site. And with only 700,000 pairs, we will be at over $1 million in revenue. The sky is the limit!

The business model is important indeed. Somebody must pay you an amount to cover your costs and, over and above that, earn a profit. So, you do need a revenue model and a cost model — preferably ones that fit together. In a world in which the numbers are often viewed as sacrosanct, the above business model would do for most.

A Model Anchored in Strategy

But my view is that you can always make up any numbers you want — and in fact all revenue forecasts are exercises in fantasy. Is $1.50/pair acceptable? Are there 700,000 users? Saying that those are the numbers doesn’t make them real — especially when it is someone else’s decision to spend/pay. So, I want the business model to be anchored in and arise out of the core features of strategy.

Because the Where-to-Play/How-to-Win (WTP/HTW) pair of choices is the heart of strategy, the business model needs to be embedded in and arise out of that choice pair. The WTP has to specify from what customers you are going to receive revenues. That is central to your business model. And it is not always straightforward in the modern economy. There are many two-sided markets where there is a ‘money side’ (e.g., advertisers who pay for Google words) and a ‘subsidy side’ (e.g., searchers who don’t pay). Congressional committees may imagine that Google and Facebook are ‘free services’ because Congress doesn’t understand two-sided market business models.

The HTW choice needs to explain how it is you will earn a better margin serving the customers specified in the WTP than your competitors. That can be accomplished either by selling at an average price combined with lower costs or by selling at a higher price combined with average costs. Your HTW has to specify a theory as to why it is, in the WTP specified, you will be able either to earn higher prices or to serve customers at a lower cost structure. That theory needs to specify both how you will get to that position and how you will maintain it. Otherwise, you don’t have a business model actually worth having. You can certainly lay it out in a spreadsheet, but it won’t be around for long and it certainly won’t look like your spreadsheet. That is because someone else will have advantage over you and will slowly but surely crush your business.

In this way, your business model arises out of your WTP/HTW choice. The WTP tells you from which customers you will be garnering revenues and the HTW tells you the level of revenues you can expect and the costs you need to spend to earn those revenues.

The reality check for strategy is the Capabilities and Management Systems (MS) choices that determine whether you can build and maintain the Capabilities that are necessary to win where you have chosen to play. The business model needs to incorporate the costs of building and maintaining these Capabilities. If your HTW requires that you are better at branding to be able to sustain premium pricing, then what resources do you need to spend in advertising on an ongoing basis? With those advertising costs, will you still maintain overall cost proximity. If your HTW requires that you have an advantaged cost position based on scale, does your scale give you the cost economies that you need? If your system requires better quality human resources, does your recruitment system cost too much? These are the kind of reality checks your business model needs to pass — or it will be just like most business models: a fantasy.

In the modern economy, there is an important role for your Winning Aspiration (WA) in determining the robustness of your business model. In most industries today, fixed costs have taken over the biggest proportion of the overall cost structure. A hundred years ago, the cost structures of most companies were weighted towards the variable costs associated with producing another unit of the product (or service). For example, building an automobile required lots of raw materials/parts and high variable labor costs, with a modest overlay of fixed costs. Now the biggest portion of the cost structure of most modern companies is in fixed costs like R&D, advertising, engineering, managerial overhead, distribution system, IT, etc. The variable costs associated with another unit are often negligible. What is the cost of serving another Facebook user? Close to zero. What is the cost of providing another copy of Office 365? Close to zero. Even a classic product company like P&G has greater fixed costs than variable costs today.

With such a cost structure, relative scale is essential to the robustness of the strategy and of the business model. In the context of any defined WTP, the player with the greatest scale will have the most attractive economics because it can spread its fixed costs more broadly than its smaller competitors. As a consequence, it will either be able to spend more in order to differentiate or achieve parity with a lower overall cost structure. For example, if it has a relative market share higher than anyone else, every dollar it spends on advertising will cost it less per unit sold than for any competitor. If instead, a competitor is bigger than you in a given WTP, its economics will be superior and that will play out with it getting relatively stronger over time and while you become relatively weaker.

In this way, each box in the Strategy Choice Cascade both defines and validates your business model. In order to have a business model that works, you need a Winning Aspiration that drives you to achieve the largest position in the chosen Where-to-Play, which has to be twinned with a How-to-Win, which generates the advantage that enables the achievement of the dominant share. And that WTP/HTW choice needs to be supported by Capabilities and Management Systems that can be built and maintained to consistently deliver the form of winning assumed in the WTP/HTW choice. If these choices are sharply made and mutually reinforcing, they will generate a business model that is a reality, not a fantasy.

Practitioner Insights

When you are asked about your business model, don’t think of it as something independent of your strategy. Start with your strategy — your Winning Aspiration, your Where-to-Play, your How-to-Win, your Capabilities, and your Management System. That will provide a more compelling rationale for why revenues will flow to you and profits over costs will accrue. If they are impatient and just want to know the numbers, you are wasting your time with them. There is no business model without a strategy. And all great strategies, generate a business model that is attractive and persistent.

Professor Roger Martin is a writer, strategy advisor and in 2017 was named the #1 management thinker in world. He is also former Dean of the Rotman School.