Business Models and Dynamic Capabilities

BUSINESS MODELS AND DYNAMIC
CAPABILITIES
David J. Teece
Thomas W. Tusher Professor in Global Business
Faculty Director, Tusher Center for The Management of Intellectual
Capital, University of California, Berkeley
Chairman, Berkley Research Group
dteece@thinkbrg.com
Copyright Teece 2017
1

I. General
II. (a) Business Model Design
(b) Business Model Evolution
III. Business Models & Strategy
IV. Business Models & Platforms
V. Business Models & Dynamic Capabilities
VI. Conclusions
2

I. GENERAL
3

 “The essence of a business model is in defining
the manner by which the enterprise delivers value
to customers, entices customers to pay for value,
and converts those payments to profit” (Teece,
2010: 172).
 The business model provides a pathway by which
technological innovation and knowhow combined
with the utilization of tangible and intangible
assets are converted into a stream of profits.
 A business model reflects management’s
hypothesis about what customers want, how they
want it, and how the enterprise can organize to
best meet those needs, get paid for doing so, and
make a profit. (Teece, 2010, p.173)
4
MY VIEW OF WHAT’S AT THE CORE OF BUSINESS MODELS

OTHER VIEWS OF THE CORE
5
 “The story that explains how an enterprise works.” (Joan Magretta)
 “The answer to the questions: Who is your customer, what does the customer value,
and how do you deliver value at an appropriate cost?” (Peter Drucker)

 There are almost as many definitions of a business model as there are business
models.
 My own definition is:
A business model articulates the logic and provides data and other
evidence that demonstrates how a business creates and delivers value to
customers. It also outlines the architecture of revenues, costs, and
profits associated with the business enterprise delivering that value.
(Teece, 2010: 173)
 Identifying unmet customer needs, specifying the technology and organization
that will address them, and capturing value are important functions of the
business model.
6
DEFINITIONS

ELEMENTS OF BUSINESS MODEL ACCORDING TO CLAY CHRISTENSEN
7
 A business model should consist of four elements:
 Customer value proposition
 Key resources
 Key processes
 Profit formula (includes value capture)
Source: Clay Christensen

MANY WELL-RECOGNIZED CATEGORIES OF BUSINESS MODELS
 Traditional sectors
 Airlines: no frills, low cost, direct flights, and on time (e.g. Southwest in the US
and RyanAir in Europe)
 Safety razor: low (no) margin on razor; high margin on blades (e.g. Gillette)
 Sports apparel: on field sponsorship to build brand and drive sales off field (e.g.
Nike, Addidas)
 Knowledge sectors
 Information/internet industries “Freemium” service search: ‘give your service
away for free, acquire a lot of customers very efficiently. Then offer premium
priced value added services or an enhanced version of your service to your
customer base.’ –e.g., Skype
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BUSINESS MODEL EXAMPLES
Type of model Description Examples
Franchise Sell the right to use the business model in
exchange for a percentage of revenue
McDonald’s, Holiday Inn
Cross Subsidy Disproportionate amount of the value is
captured from components or refills
Gillette, Hewlett-Packard
printers
Pay as you go Pay on the basis of what you consume Some mobile phone contracts
Subscription
model
Recurring revenue model Health clubs, Cable TV
Direct sale Removal of intermediaries in a supply chain Dell computer, farmers’ markets
Online
auctions
Create a community of buyers and sellers eBay
Freemium Offers a basic service to consumers for free,
while charging for premium services to paying
members
LinkedIn
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II. (A) A BUSINESS MODEL DESIGN
(ABBREVIATED)
10

11
ELEMENTS OF BUSINESS MODEL DESIGN
 Designing a business model involves figuring out, implementing and then refining
commercially viable architectures for revenues and for costs – how to create value,
deliver value to the customer and capture value while doing so (Teece, 2010).
 A new business model requires creativity, insight, and customer, competitor, and
supplier information and intelligence (Teece, 2010, p.186)
 Start with a provisional business model: validate, then revalidate and revise.
 The “right” business model is rarely apparent early on…entrepreneurs/managers who
are well positioned and can learn and adjust are more likely to succeed.


GENERATING A VIABLE CUSTOMER VALUE PROPOSITION SOULD COME FIRST
 The development of a good business model starts with a deep understanding of the
customer’s predicament and from familiarity with the dozens of models that exist
already.
 The initial step is to sense the existence of customers with unmet needs who are
willing and able to pay for a product or service that can rectify their predicament.
 A value proposition is a statement which clearly summarizes why a consumer should
buy a particular product or a service. It should convince consumers that this product
or service is better than others on the market.
12

VALUE CAPTURE
13
 “Value capture” refers to the efforts to capture some of the created
value –“make money”
 Rewards will not automatically follow even if value is created.
 Value capture involves setting prices and costs so that a company
can earn a profit on their products.

CAPTURING VALUE FROM AN INVENTION/INNOVATION IS AN IMPORTANT PIECE OF A
BUSINESS MODEL (STRATEGIC) DESIGN IN THE HIGH TECH CONTEXT:*
One must:
 Take into account the ‘appropriability regime’ and the innovator’s existing asset
position.
 Be explicit about how to organize the value chain to profit from innovation
 Choose from among three structural types:
Integrate
• Innovator produces and
markets the invention
embedded in product or
service; entire value
chain kept/built in-house
Hybrid
• Innovator markets the
product or service but
out-sources production
Contract/License
• Innovator licenses; only
viable with strong
intellectual property
rights
*D Teece “Profiting from Technical Innovation”, Research Policy, December 1986.
14

COMBINING THE ELEMENTS OF BUSINESS MODEL DESIGN
Select technologies and features
to be embedded in the
product/service
Determine benefit to the
customer from consuming/using
the product/service
Identify market segments to be
targeted
Confirm available revenue
streams
Configure costs appropriately
Design mechanism to capture
value
Teece, 2010
Create value for customers, entice payments, and convert payments to profits
15

 Elements of a business model must be internally aligned and coherent (Ritter,
2014).
 For example, the (ordinary) capabilities of the firm must be able to provide
the planned customer value. Furthermore, the business model must be
aligned with the internal structure and overall management model of the
company (Birkinshaw and Ansari, 2015).
 Extreme business model transitions within an existing business are unlikely to
succeed without major financial resources and steely commitment.
 For example, taxi cab companies are not attempting to replicate the ride-
sharing capabilities of Uber or Lyft because those models are based
primarily on software and data skills.
16
IMPORTANCE OF ALIGNMENT & COHERENCE

SAMPLE QUESTIONS TO ASK WHEN DEVELOPING A (PROVISIONAL) BUSINESS
MODEL
Figure 3 in D. Teece, “Business Models, Business Strategy and Innovation”, Long Range Planning, 2010
17

 Business models are seldom successful “out of the box” and must be fine-
tuned—and sometimes completely overhauled—before they can become profit
engines. Start-ups generally find transformation easier than do mature firms
because they have fewer established assets and procedures to re-engineer.
 The “lean start-up” model that has spread well beyond Silicon Valley includes
the capacity to “pivot” to quickly test, discard, and replace ideas and business
models that do not work (Ries, 2011).
 This is especially relevant & possible for software-intensive Internet-based
business models (where pivoting is relatively easy because much software can
be repurposed) and in circumstances where social media can provide fast
feedback.
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LEARNING & PIVOTING WILL BE REQUIRED WHEN ROLLING OUT A NEW BUSINESS
MODEL

II. (B) BUSINESS MODEL
EVOLUTION
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 Business model transitions that fit comfortably with the existing business are far
easier to implement than a complete revamp.
 This rarely suffices to restore a competitive advantage that is under assault
 For example, Goldman Sachs was able to increase its business for a complex
debt instrument known as structured notes by allowing outside issuers access
to financial advisers through a Goldman app (Demos and Hoffman, 2016).
 The ability of outside banks to reach clients through Goldman software marks a
major change of a business model element
 Soon after the app was introduced, Goldman become the largest issuer of
structured notes where it had previously been only a small player.
20
INCREMENTAL BUSINESS MODEL CHANGES ARE DIFFICULT BUT POSSIBLE

RADICALLY DIFFERENT BUSINESS MODELS ARE ENABLED & REQUIRED BY
TECHNOLOGICAL PROGRESS
 In an earlier era, the telegraph and the railroads enabled and triggered scale and
scope (Chandler, 1990) and big changes in organization.
 Today, the Internet has enabled new business models that are sometimes
orthogonal to scale, allowing niche activities to thrive.
 But it has also unleashed massive network effects such as when business
models employ n-sided markets, like eBay, that connect large but scattered
groups of small buyers and small sellers on a global scale (Armstrong, 2006).
 Most “new” (to a given firm) business models will be similar to older ones,
involving a permutation or hybridization of existing models.
21

 A new wave of business model innovation will likely accompany the emergence of
the “internet of things” (IOT)
 This creates opportunities to meter how customers use a product, which
might, for example, enable a model of usage-based rental instead of a one-
time sale.
 Moreover, the availability of massive amounts of data from the sensors distributed
throughout the IOT creates information & data that can be sold or used
22
THE INTERNET OF THINGS [IOT]

 With so many possibilities and pitfalls for creating models, the dynamic capability
to mix and "remix" or "orchestrate" business model components takes on
particular salience.
 In fact, the components of a business model are capability to construct, to
some extent a type of “organizational asset.
 Business model components are not perfectly modular because changes in one
will generally entail changes in one or more of the others.
 There are limits to “mix and match”. If substitution and addition transform a once-
simple business model into a complex system, “emergent” properties, which can
include unwelcome surprises, are likely (Kay and Teece, 2014).
23
CREATING NEW BUSINESS MODELS THROUGH “MIX & MATCH”?

 The opportunities for recombination are virtually endless.
 A video game maker might offer “freemium” versions of games likely to find a
mass audience but charge up-front fees for specialized games designed for a niche
audience with a high willingness to pay.
24

RYANAIR’S BUSINESS MODEL THEN AND NOW
25
Then
This depiction of Ryanair’s business model in the 1980s highlights the airline’s major choices
at the time: offering excellent service and operating with a standardized fleet. The airline was
forced to redesign its business model in the face of stiff competition.
R. Casadesus-Masanell & J. Ricart, Harvard Business Review, Jan-Feb 2011 Issue

RYANAIR’S EMBELLISHED BUSINESS MODEL, CONTINUED
26
Now
Ryanair’s current business model rests on the key choices of offering customers low fares
and providing nothing free. It has a reputation for fair fares and low fixed costs. Ryanair’s
choices are aligned with its goals, generate cycles that reinforce the business model, and
are robust given that it has been operating as a low-cost airline for 20 years.
R. Casadesus-Masanell & J. Ricart, Harvard Business Review, Jan-Feb 2011 Issue

SPACE X RAISES CHALLENGING BUSINESS MODEL ISSUES
Space X Timeline (Elon Musk, founder)
2002 Founded
2006 NASA selects Space X for commercial space
transport
2010 Space X wins $1.6 billion NASA contract to
bring supplies to the International Space
Station.
2011 Space X flies Dragon Capsule & returns
back to Earth
2014 Space X first commercial satellite launch
2017 Launched previously used rocket with
satellite on board & landed the first stage
of the Falcon 9 back on a barge
Space X’s new Merlin Engine was the first new liquid fuel rocket to fly to the US
since the 1990’s

SPACE X BUSINESS MODEL
Private sector approach to space exploration for commercial & other purposes
 Vision: Colonize Mars and make human a multi-planet civilization
 Insurance against global catastrophe
 Value proposition: Affordable ticket to Mars
 Value Capture: Somehow access NASA funding (Mike Griffin at NASA was
collaborative and found ways to find finding in existing 1958 charter/law,
plus funding from Silicon Valley friends
28

 Technology: Liquid fuel reusable rockets
 Strategy: 10x cheaper than those currently in use
 Organization Strategy: Do as much as possible in-house because the existing supply
chain is wedded to defense contractors who are too cost-insensitive (cost plus
contracting mobility)
 Reject outsources (i.e. Made hatch fitting out of off-the-shelf- bathroom fittings
 Adopt a “lean startup” approach and “test and fly repeatedly”
29

Market Segments
 Satellite launches- low orbit Wi-Fi service?
 Terrestrial passenger flight
 Space tourism
 Asteroid mining
 Exploration of the planets
30

INADEQUATE REACTION TO TECHNOLOGICAL & BUSINESS MODEL CHALLENGES-THE CASE
OF KODAK
 Invented mass market (emulsion) film-based cameras in the early 1900’s & grew to
dominance
 Was a pioneer in digital film technology; but anti-cannibalization instincts blocked
commercialization
 Kodak management (a) had no sense of urgency even while other companies
commercialized digital cameras, and (b) Did not see the camera phone as a threat
 Eventually entered the digital camera and color printer market but it was too late
 Declared bankruptcy in 2012
31

ALWAYS ASK IF YOU CAN DO BETTER
Business model innovation can occur in a number of ways: by adding
new activities, by linking activities in novel ways- or by changing one or
more parties that perform any of the activities.
R.Amit & C. Zott, “Creating Value Through Business Model Innovation”, MITSloan Mangement
Review, Spring 2012, Vo;.53 No.3.

III. BUSINESS MODELS &
STRATEGY
33

BUSINESS MODEL AND STRATEGY
34
 Business model
 The logic of the company – how it operates and creates and captures value for
stakeholders in a competitive market place
 Strategy
 A business model is more generic than a business strategy…i.e. a business
model can be associated with several strategies.
 Coupling business model and strategy with business model and its
implementation is necessary for sustaining a competitive advantage.
Source: Casadesus-Masanell & Ricart, 2011

 A business model shapes strategy inasmuch as it constrains some actions and
facilitates others.
 By determining costs and profitability, a business model impacts the very
feasibility of a strategy.
 In the event of a conflict between strategy and the business model, it falls to top
management to determine which of the two should change.
35
BUSINESS MODELS STRATEGY, CONTINUED

 It is important to determine which market segments to target.
 Good business models may be scalable across multiple segments, but
knowing which segment(s) to pursue first is critical.
 While segmentation is not part of business model design as such, it is part
of the marketing strategy that can make a business model successful.
36
DIFFERENT BUSINESS MODELS MAY BE NEEDED FOR DIFFERENT MARKET SEGMENTS

GOOD STRATEGY WILL INVOLVE THINKING THROUGH THE IMITABILITY ISSUE
37
 Include “isolating mechanisms” that impede copycat behavior
 Implementing a business model may require systems, processes and assets that are
hard to replicate
 There may be a level of opacity that makes it difficult for outsiders to understand in
sufficient detail how a business is implemented
 Even if it is obvious how to replicate a pioneer’s business model, incumbents may
be reluctant to do so if it involves cannibalizing existing sales and profits.
Teece (2010)

 Pioneering a new business model is not, however, always a path to advantage.
 For example, while containerized shipping was pioneered in the late 1950s by a
U.S. shipper later known as Sea-Land Service, the business is today dominated by
others.
 Maersk Line, a rival shipper that waited some twenty years before adopting
containerization, was one of the latest adopters yet is now the largest, having
acquired Sea-Land in 1999.
 Maersk was able to wait for standards and technology to mature, then move
decisively by building large ships and modern port facilities that it was then
able to orchestrate effectively
38
BEING THE BUSINESS MODEL PIONEER IS RARELY A SURE ROAD TO SUCCESS

IV. BUSINESS MODELS & PLATFORMS
39

 An important distinction is the one between business models
that are also “platforms” and those that are not.
 A current example of a platform with an installed base effect is
Uber and its rival clone Lyft.
 Uber’s business model merits closer inspection
40
BUSINESS MODELS & PLATFORMS

41
Traditional Taxi Uber
GPS driver guidance Optional Mandatory
Know exact location and arrival time of
vehicle
No Yes
Spend time in vehicle on payment Yes No
Easy choice of vehicle class No Yes
Drivers are employees or independent
contractors
Mixture Independents
Common procedure across geographies Locally Globally
Tipping involved Yes No
Easy ability to provide feedback on
service
No Yes
Can be hailed on the street Yes No
Customer acquisition aided by: Partnerships App
Driver owns or leases car Mixed Yes
Computer dispatched Mixed Yes
Payment Cash or credit Cashless (cards only)
How company is paid
Mixed (revenue and profit
split, plus per diems)
Revenue split with driver
Customer rating of driver Difficult and not required Easy and required
Urban ride sharing business model comparison

 The platform, the driver contracts, and the brand
are the key assets, not cars, taxi medallions, or the
local street knowledge of the drivers.
 Uber’s corporate strategy is to focus more on how
to enter new markets and less on how to expand
in existing ones.
 The latter can happen more or less organically
once acceptable driver density is achieved.
42

UBER’S TECHNOLOGY AND BUSINESS MODEL REFLECT THE CONCEPT OF THE
“COHERENCE” OF DIFFERENT ELEMENTS OF THE BUSINESS MODEL AND STRATEGY
 Uber’s GPS requirement, provides predictable response time for the customer while
facilitating the driver’s identification of the customer’s location.
 Preapproving credit shortens the exit time from the vehicle, improving the experience
of customers and drivers
 The ease of entry for drivers opens up employment opportunities for drivers from all
walks of life.
43
The Uber “app” is of course the linchpin of the business model.

EVERYONE CAN BE A DRIVER
Flexibility to drive Extra Income Drive with Assurance
VALUE PROPOSITION
EVERYONE’S PRIVATE DRIVER
One tap to ride Reliable Pickup Status Sharing Ride Feedback Cashless
44

45
VALUE PROPOSITION – NOT JUST A CHEAPER
RIDE COMPARED TO TAXIS

Uber’s structure is simpler, thus generating lower costs which allows them to offer a
lower price
 No inventory
 Uber doesn’t have to pay regulatory fees as they are not “taxi service operators”
They are network orchestrators matching drivers and passengers
Drivers do not have to pay professional fees to deliver the service
Uber drivers are partners not employees
 Ease of becoming a driver
 More drivers than taxi drivers in NYC 1
 Majority of drivers are part-time , only 38% work full-time 2
 Part-time drivers can accept lower revenues than taxi drivers
1http://www.digitaltrends.com/mobile/more-uber-cars-yellow-taxis-nyc/
2http://techcrunch.com/2015/01/22/uber-study/
4
6
SUPPORTIVE ELEMENTS OF THE UBER MODEL

CUSTOMER SEGMENTS (BYNEEDS)
I want a ride (Taxi, UberX, UberTaxi, Lyft)
I want a luxury ride (Limousine Taxi, UberBlack)
I’m willing to pay more to get a ride NOW (UberX,
Lyft)
 I want the highest probability of getting a ride
I want to share the ride to reduce cost (UberPool)
I want a scheduled ride
I want a consistently good user experience (Uber,
Lyft)
Key Differentiators between the
different options:
Price
Time
User experience
Options
47

VALUE CAPTURE
Pricing & Payment
 Uber sets prices for rides
 Peak hours
 Customers pay Uber with a
credit card (not the drivers)
From revenues to Profits
 Uber covers expenses
(R&D, marketing…)
 Employees & infrastructure
in cities
Splitting the Proceeds
 20% of the ride goes to
Uber
 Commission-based
 Depends on the city and
competition
Reinvest to Grow
 R&D and acquisition of new
businesses
4
8
21

ALTERNATIVE BUSINESS MODELS – CUSTOMERSEGMENTS
UberAlternate
 Similar to UberX but using other forms of transport
e.g. bicycles or motorbikes.
 Target segment: Passengers in developing countries /
countries where public transport is not well
established
UberAlternateX
 High-end luxury transport
 Target segment: luxury
 High-end cars
49

ALTERNATIVE BUSINESS MODELS – VALUECAPTURE
Copyright Teece 2017 5
0
UberCredits
 Passenger can buy $100 of UberCredits and be rewarded with an extra $20.
 This entices more passengers to use Uber, which will increase demand and make drivers
happier.
UberAdvertising
 Advertisements on the app and within the car
 Advertising revenue

INNOVATIVE FEATURES AND ADVANTAGES OF UBER’S BUSINESS MODEL
51
 Unique revenue models
 Different car models to cater to everyone
 Uber’s dynamic pricing model
 Doing away with most physical costs
 Owning inventory is a liability; the Uber model of business is a
relief in this regard.

Uber Lyft
Selected differences in Value Creation
Service areas Larger service area (250 cities in
53 countries)
65 cities in the US
(Initial) Branding
position
Promotes itself as luxurious
“everyone’s private driver”
Promotes itself as fun (pink mustache)
Started as long-distance “ride sharing”
platform for college students, Zimride
Culture An Uber driver is a chauffeur. It’s
run with military precision;
professionalism is encouraged
from drivers.
A Lyft driver is a good friend. It provides a
clean car and has fun. The culture is goofy, fun,
unique, and irreverent, just like a true bud.
Selected differences in Value Capture
International
alliance
Competes with international
rivals
Collaborates with foreign competitors (e.g.,
Ola, the “Uber of India,” ; Didi Chuxing, the
“Uber of China”)
Uber’s potential responses to imitation
1. Build a natural monopoly through network effects – the more people who use your service,
the better your service becomes, leading to a positive upward spiral
2. Create a product superior to the alternatives to cement customer loyalty
52
IS UBER PROTECTED FROM IMITATION?

UBER-LIKE MODELS ARE PROLIFERATING
 Wag! (wagwallking.com) is the Uber of dog walking.
 Handy follows a similar model for house cleaning, with local independent
contractors that accept jobs on the basis of location and timing.
53
Many market verticals remain to be addressed, all with their own
idiosyncrasies, needs, opportunities, and constraints.

V. BUSINESS MODELS &
DYNAMIC CAPABILITIES
54

 Dynamic capabilities, which are underpinned by organizational routines and
managerial skills, are the firm’s ability to integrate, build, and reconfigure
internal competences to address, or in some cases to bring about, changes
in the business environment (Teece et al., 1997; Teece, 2007).
 The crafting, refinement, implementation, and transformation of business
models are the output of high-order (dynamic) capabilities.
 The strength of a firm’s dynamic capabilities is vital in many ways to its
ability to maintain profitability over the long term, including the ability to
design and adjust business models.
55
BUSINESS MODELS & DYNAMIC CAPABILITIES

SIMPLIFIED SCHEMA OF DYNAMIC CAPABILITIES, BUSINESS MODELS, AND STRATEGY
56

VI. CONCLUSIONS
57

 The success of a business depends as much on
business model design and implementation as it does
on the selection of technologies and the operation of
tangible assets and equipment.
58

 There is no one “right” business model design. Choosing and honing a
business model requires strong dynamic capabilities, to be discussed next,
and strategic analysis, which will be discussed later on.
 Dynamic capabilities, can enable an enterprise to upgrade its ordinary
capabilities and direct these, and the capabilities of partners, toward high-
payoff endeavors.
 Dynamic Capabilities requires “orchestrating,” the firm’s (and partner firms’)
resources to address and even shape changes in the marketplace, or the
business environment more generally.
59

POORLY RUN FIRMS ARE UNAWARE OF BUSINESS MODEL CHOICES AND
THEREFORE FAIL TO CHOOSE FROM THE FULL MENU
 In a firm with strong dynamic capabilities, management has greater freedom to
contemplate business models that entail radical shifts of resources or activities.
 Firms with weaker dynamic capabilities, to the extent that they even recognize a
new opportunity, will be more likely to adopt business models that lean on past
investments and existing organizational processes.
60

REFERENCES
• D.J.Teece, “Business Models, Business Strategy and Innovation,” Long Range Planning
43, Amsterdam: Elsevier Science, (2010), 172–194.
• D.J.Teece,“Business Models, Value Capture, and the Digital Enterprise”,
(Forthcoming, Journal of Organization Design).
• D.J.Teece,“Profiting from Innovation in the Digital Economy: Standards,
Complementary Assets, and Business Models in the Wireless World”, (Forthcoming,
research policy).
• R. Casadesus-Masanell & J. Ricart, Harvard Business Review, Jan-Feb 2011 Issue.
• R.Amit & C. Zott, “Creating Value Through Business Model Innovation”, MITSloan
Mangement Review, Spring 2012, Vo;.53 No.3.
61

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