Can elephants dance? Big companies are less likely to invest in new technologies than start-ups. Henry Chesbrough, Professor at HBS, and Richard S. Rosenbloom, Emeritus Professor, rely on your business model and not on the technology itself when evaluating investment decisions.
By Henry Chesbrough and Richard S. Rosenbloom
Excerpt from “The Two-edged Role of the Business Model to Optimize the Company’s Technology Investments,” in Technical Risks: How Innovators, Managers, and Investors Manage the Risks Associated with High Technology, Article © President and Employee of Harvard College, 2001; Book © MIT Press, 2001.
This excerpt is from a contribution essay titled Take on Technical Risks: How Innovators, Executives, and Investors Manage High-Tech Risks, published by Lewis M. Branscomb and Phillip E. Auerswald. Chesbrough and Rosenbloom discuss the need for successful companies to evaluate the potential value of new technologies by first contrasting them with the company’s business model.
We argue that successful companies interpret the potential value of emerging technologies in the context of the prevailing business model that is already established in the business. The reward expected of an innovative company must be assessed against a specific business model that determines how, with whom, and at what cost, revenue is generated. In other words, technology does not create value in a vacuum. The established model may or may not be appropriate for the opportunities associated with the new technology. Otherwise, the use leads to inaccurate analysis and low investment. This is one of the causes of the bias of successful companies faced with new technologies, and we dedicate ourselves to the rest of our discussion.
The business model concept
This term “business model” is widely used but is rarely well defined. In our use, the functions of a business model are as follows:
identify a market segment, ie the users for whom the technology is useful for which purposes;
articulate the value proposition, ie the value created by the technology-based offer to users;
Define the value chain structure, that is, the network of activities within the enterprise, required to create and distribute the products or services offered to customers.
Estimate the cost structure and profit potential of the supply generation based on the value proposition and the structure of the selected value chain;
Describe the company’s position in the value chain, connecting suppliers and customers, and identify complementary and potential competitors
Formulate the competitive strategy that allows the innovative company to gain and maintain a lead over its competitors.
The definition of a business model for commercializing a new technology begins with the formulation of a value proposition inherent in the new technology. The model must also specify a customer group or a market segment for which the proposal is attractive and from which the resources are distributed. Value, of course, is an economic concept that is not measured primarily by physical performance, but by what the buyer pays for a product or service. A customer can appreciate a technology because of its ability to reduce the cost of solving an existing problem or the ability to create new opportunities. One of the tricky aspects of defining the technology manager business model is that the physical area of inputs needs to be linked to an economic production area, which is sometimes associated with great uncertainty.
Value … derived from the structure of the situation, not from some inherent characteristics of the technology
CHESBROUGH & ROSE BLOOM
The value therefore results from the structure of the situation and not from certain characteristics of the technology itself: The realization of value increasingly also involves third parties. The value chain, which focuses on a particular business, determines the role that suppliers and customers play in influencing the value of marketing an innovation. Parts of the value chain can benefit from the coordination if it increases the value of the network for all participants.
You need to target the market to start the process to find out which technological attributes to target in development and how to solve the many trade-offs that occur during development. Cost against performance or weight against performance. The technical uncertainty depends on the market and varies with the dynamics of market changes.
Identification of a market is also required to define the “revenue architecture”, ie how a customer pays, how much is calculated and how the value is split between customers, companies and suppliers. The options cover a wide range, including selling, leasing, transactional billing, advertising and subscription models, licenses and even selling the product and selling support and customer services.
When you get an idea of price and cost, target profit margins are generated for the opportunity. Target margins provide the reasons for the actual and financial assets required to realize the value proposition. Margins and assets together form the threshold of financial scalability of the technology in the available activities. In order for the business to grow, it must provide investors with a credible prospect of an interesting return on the assets required to build and expand the model.
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Prejudices introduced by an established business model can have two consequences. First, as already mentioned, they can mask the revenue potential of a valid new technology to which the model is not properly applied. On the other hand, a model that has been remarkably successful in a number of new companies can therefore lead to exaggerated expectations regarding the merits of under-researched innovation. This last effect is similar to the force known as “technological thrust”. In such cases, the enthusiasm for new technology, especially in connection with the thirst for sales growth, can lead to investments in the commercialization of innovations without sufficiently controlling their economic potential.