CHAPTER 6

Formulating Business Unit Strategy

Introduction

Business unit strategy involves creating a profitable competitive position for a business within a specific industry or market segment. Sometimes called competitive strategy, its principal focus is on how a firm (or profit center) should compete in a given competitive setting. In contrast, an overarching corporate strategy is concerned with the identification of market arenas where a corporation can compete successfully and how, as a parent company, it can add value to its strategic business units (SBUs).

Deciding how to compete in a specific market is a complex issue for a business. Optimal strategies depend on many factors, including the nature of the industry; the company’s mission, goals, and objectives; its current position and core competencies; and major competitors’ strategic choices.

We begin our discussion by examining the logic behind strategic thinking at the business unit level. We first address the basic question: What determines relative profitability at the business unit level? We look at the relative importance of the industry in which a company competes and the competitive position of the firm within its industry, and we identify the drivers that determine sustainable competitive advantage. This logic naturally suggests a number of generic strategy choices—broad strategy prescriptions that define the principal dimensions of competition at the business unit level. The generic strategy that is most attractive, and the form that it should take, depends on the specific opportunities and challenges. The chapter next deals with the question of how to assess a strategic challenge. A variety of useful techniques is introduced for generating and evaluating strategic alternatives. The final section addresses the issue of designing a profitable business model.

SBU Disruptions Come from Myriad Sources

When a group of CIOs was asked to predict the ways that technology would disrupt industries by 2525, they gave the following responses:¹

Each of these likely changes will disrupt the business plan of countless numbers of corporate SBUs and independent businesses. Each business will need to formulate a revised plan for attracting and serving customers. 

Foundations

Strategic Logic at the Business Unit Level

What are the principal factors behind a business unit’s relative profitability? How important are product superiority, cost, marketing and distribution effectiveness, and other factors? How important is the nature of the industry?

Although there are no simple answers to such questions, and the attractiveness of different strategic options depends on the competitive situation analyzed, much has been learned about what drives competitive success at the business unit level.

We begin with the observation that, at the broadest level, firm success is explained by two factors: the attractiveness of the industry in which a firm competes and its relative position within that industry. For example, the seemingly insatiable demand for new products in the early days of the software industry guaranteed big profits for the industry leaders and for many of their smaller rivals. In the fiercely competitive beer industry, however, relative positioning is a far more important determinant of profitability, as Budweiser’s unprecedented performance has shown.

How Much Does Industry Matter?

In a comprehensive study of business performance in four-digit Standard Industrial Classification (SIC) code categories, academic research provides an answer to the question: How much does industry matter? Researchers have found that industry, industry segment, and corporate parent accounted for 32 percent, 4 percent, and 19 percent, respectively, of the aggregate variance in business profits, with the remaining variance spread among many other less consequential influences. These results support the conclusion that industry characteristics are an important determinant of profit potential. Industry directly accounted for 36 percent of the explained total variation in profitability.²

Relative Position

The relative profitability of rival firms depends on the nature of their competitive position (i.e., on their ability to create a sustainable competitive advantage vis-à-vis their competitors). The two generic forms of sustainable competitive positioning are a competitive advantage based on lower delivered cost and one based on the ability to differentiate products or services from those of competitors and command a price premium relative to the cost incurred.

Whether lowest cost or differentiation is most effective depends, among other factors, on a firm’s choice of competitive scope. The scope of a competitive strategy includes elements such as the number of product and buyer segments served, the number of different geographic locations in which the firm competes, the extent to which it is vertically integrated, and the degree to which it must coordinate its positioning with related businesses in which the firm is invested.

Decisions about scope and competitive advantage are based on a detailed understanding of customers’ values and a company’s capabilities and opportunities relative to its competitors. In this sense, strategy reflects a firm’s configuration of different elements. Competitive advantage results when a company has a better understanding of what customers’ desire, when it learns to meet those customer needs at a lower cost than its rivals, or when it creates buyer value in unique ways that allow it to charge a premium.

The Importance of Market Share

The relative importance of market share as a strategic goal at the business unit level has been the subject of considerable controversy. Arguing that profitability should be the primary goal of strategy, some analysts believe that executives have been led astray by the principal pursuit of market share.³ Many failed companies have achieved high market shares, including Great Atlantic & Pacific Tea Company (A&P) in grocery sales, Intel in memory products, and WordPerfect in word processors. Thus, executives must ask themselves: Are we managing for volume growth or value growth?

Formulating a Competitive Strategy

Key Challenges

Managers face four key challenges in formulating competitive strategy at the business unit level: (1) analyzing the competitive environment, (2) anticipating key competitors’ actions, (3) generating strategic options, and (4) choosing among alternatives.

The first challenge, “analyzing the competitive environment,” deals with two questions: With whom will we compete, now and in the future? What relative strengths will we have as a basis for creating a sustainable competitive advantage? Answering these questions requires an analysis of the remote external environment, the industry environment, and internal capabilities.

The second challenge, “anticipating key competitors’ actions,” focuses on understanding how competitors are likely to react to different strategic moves. Industry leaders tend to behave differently from challengers or followers. A detailed competitor analysis is helpful in gaining an understanding of how competitors are likely to respond and why.

The third challenge, “identifying strategic options,” requires a balancing of opportunities and constraints to craft a diverse array of strategic options ranging from defensive to preemptive moves. The fourth challenge, “choosing among alternatives,” requires an analysis of the long-term impact of different strategy options as a basis for a final choice.

What Is Competitive Advantage?

A firm has a competitive advantage when it is successful in designing and implementing a value-creating strategy that competitors are not currently using. The competitive advantage is sustainable when current or new competitors are not able to imitate or supplant it.

A competitive advantage is often created by combining strengths. Firms look for ways to exploit competencies and advantages at different points in the value chain to add value in different ways. Southwest Airlines’ industry-best 15-minute turnaround time for getting airplanes back into the air, for example, is a competitive advantage that saves the firm $175 million annually in capital expenditures and differentiates the firm by allowing it to offer more flights per plane per day. The use of value analysis helps a firm to focus on areas in which it enjoys competitive advantages and to outsource functions in which it does not. To enhance its cost leadership position, Taco Bell outsources many food preparation functions, thereby allowing it to cut prices, reduce employees, and free up 40 percent of its kitchen space.

It is important for executives to understand the nature and sources of a firm’s competitive advantages. They should also make sure that middle managers understand the competitive advantages, because the managers’ awareness allows for a more effective exploitation of such advantages and leads to increased firm performance. Therefore, building a competitive advantage is rooted in identifying, practicing, strengthening, and instilling throughout the organization those leadership traits that improve the firm’s reputation among its stakeholders. As a consequence, a focus on organizational learning and on creating, retaining, and motivating a skilled and knowledgeable workforce may be the best way for executives to foster competitive advantages in a rapidly changing business environment.

Competitive Advantage in Three Circles

There is considerable appeal and anecdotal evidence that a company must build a distinct competitive advantage to grow and be profitable over the long term. However, it is difficult for many strategists to articulate clearly what their company’s competitive advantage is and how it differs from those of competitors. Joel Urbany and James Davis have developed a clever, useful, and simple tool to help in this assessment called “three circle analysis.”⁴

The strategizing team of executives should begin their analysis by thinking deeply about what customers of their type of product or service value and why. For example, they might value speedy service because they want to minimize inventory costs with a just-in-time inventory system.

Next, the strategists should draw three circles as shown in Figure 6.1. The first circle (seen on the top right) is to represent the team’s consensus of what the most important customers or customer segments needs or wants from the product or service.

Urbany and Davis observe that even in very mature industries customers do not articulate all their wants conversations with companies. For example, there was no consumer demand on Procter & Gamble (P&G) to invent the Swiffer, whose category contributes significantly to the company’s recent double-digit sales growth in home care products. Instead, the Swiffer emerged from P&G’s careful observation of the challenges of household cleaning. Therefore, in conducting this initial phase of competitive advantage analysis, the consumers’ unexpressed needs can often become a growth opportunities.

The second circle represents the team’s view of how customers perceive the company’s offerings (seen on the top left). The extent to which the two circles overlap indicates how well the company’s offerings are fulfilling customers’ needs. The third circle represents the strategists’ view of how customers perceive the offerings of the company’s competitors.

Figure 6.1 Competitive advantage analysis

Each area within the circles is important, but areas A, B, and C are critical to building competitive advantage. The planning team should ask questions about each:

As Urbany and Davis explain, the team should form hypotheses about the company’s competitive advantages and test them by asking customers. The process can yield surprising insights, such as how much opportunity for growth exists in space G. Another insight might be what value the company or its competitors create that customers do not need (D, F, or F). For example, Zeneca Ag Products discovered that one of its most important distributors would be willing to do more business with the firm only if Zeneca eliminated the time-consuming promotional programs that its managers thought were an essential part of their value proposition. However, the big surprise is often that area A, envisioned as huge by the company, is often quite small in the eyes of the customer.

Value Chain Analysis

In competitive terms, value is the perceived benefit that a buyer is willing to pay a firm for what a firm provides. Customers derive value from product differentiation, product cost, and the ability of the firm to meet their needs. Value-creating activities are, therefore, the discrete building blocks of competitive advantage.

A value chain is a model of a business process. It depicts the value creation process as a series of activities, beginning with processing raw materials and ending with sales and service to end users. Value chain analysis involves the study of costs and elements of product or service differentiation throughout the chain of activities and linkages to determine present and potential sources of competitive advantage.

The value chain divides a firm’s business process into component activities that add value: primary activities that contribute to the physical creation of the product and support activities that assist the primary activities and each other. Charles Schwab successfully used its expertise in a support activity to create value in a primary activity. The firm offers a broad range of distribution channels (primary activity) for its brokerage services and holds extensive expertise in information technology and brokerage systems (support activities). Schwab uses its IT knowledge to create two new distribution channels for brokerage services—E-Schwab on the Internet and the Telebroker touch-tone telephone brokering service—both of which provide value by delivering low-cost services.⁵

Once a firm’s primary, support, and activity types are defined, value chain analysis assigns assets and operating costs to all value-creating activities. Activity-based cost accounting is often used to determine whether a competitive advantage exists.

A firm differentiates itself from its competitors when it provides something unique that is valuable to buyers beyond a low price. Dell’s ability to sell, build to order, and ship a computer to the customer within a few days is a unique differentiator of its value chain. Benetton, the Italian casual wear company, reconfigured its traditional outsourced manufacturing and distribution network to achieve differentiation.⁶ Its executives reasoned that the company could improve its flexibility by directly overseeing key business processes throughout the supply chain. If specific activities reduce a buyer’s cost or provide a higher level of buyer satisfaction, customers are willing to pay a premium price. Sources of differentiation of primary activities that provide a higher level of buyer satisfaction include build-to-order manufacturing, efficient and on-time delivery of goods, promptness in responding to customer service requests, and high quality.

It is important to identify the value that individual primary and support activities contribute beyond their costs. Different segments of the value chain represent potential sources of profit and, therefore, define profit pools.⁷ Value chain analysis showed Nike and Reebok how their core competencies in product design (a support activity) and marketing and sales (primary activities) created value for customers. This conclusion led Nike to outsource almost all other activities. In a second case, after completing a detailed value chain analysis, Millennium Pharmaceuticals opted to shift from drug research in the upstream portion of the industry to drug manufacturing downstream, to improve its profitability. This strategy was derived from the firm’s clear understanding of the entire pharmaceutical value chain and its newly recognized ability to exploit different profit pools.⁸

Analyzing the value chains of competitors, customers, and suppliers can help a firm add value by focusing on the needs of downstream customers or the weaknesses of upstream suppliers.⁹ Dow Chemical captures value from downstream rubber glove producers, to whom it used to sell chemicals, by making the gloves themselves. BASF adds value by leveraging its core competencies in the paint-coating process by painting car doors for automobile manufacturers, instead of just selling them the paint.

Value chain analysis can also be used to shape responses to changing upstream and downstream market conditions through collaboration with customers and suppliers to improve speed, cut costs, and enhance the end customer’s perception of value. This is especially true as intercompany links such as electronic data integration systems, strategic alliances, just-in-time manufacturing, electronic markets, and networked companies blur the boundaries of many organizations.

Approaching value chain analysis as a shared process involving the different members of the chain can optimize a firm’s value creation by minimizing collective costs. Dell, for example, shares information about its customers with its suppliers. This improves its suppliers’ ability to forecast demand, which results in reduced inventory and logistics costs for Dell and the suppliers. Home Depot and General Electric (GE) established an alliance between their value chains that reduces direct and indirect costs for each firm. A web-based application links Home Depot’s point-of-purchase data to GE’s e-business system and enables Home Depot to ship directly to its customers from GE. The value chain to value chain connection enables Home Depot to sell more GE products and to reduce the inventory in its own warehouses. In addition, GE can use the real-time demand information from Home Depot to adjust the production rate of appliances.

With advances in information technology and the Internet, companies can monitor value creation across many activities and linkages. For purposes of monitoring, it is useful to distinguish between the physical and virtual components of the value chain. The physical value chain represents the use of raw materials and labor to deliver a tangible product. The virtual value chain represents the information flows underlying the physical activities evident within a firm. Engineering teams at Ford Motor Company optimize the physical design process of a vehicle using real-time collaboration in a virtual workplace. Oracle Corporation is a front-runner in adding virtual value for the customer by using the Internet to directly test and distribute their software products.

Porter’s Generic Business Unit Strategies

Differentiation or Low Cost?

Earlier, we distinguished between two generic competitive strategic postures: low cost and differentiation. They are called generic because in principle they apply to any business and any industry. However, the relative attractiveness of different generic strategies is related to choices about competitive scope. If a company chooses a relatively broad target market (e.g., Walmart), a low-cost strategy is aimed at cost leadership. Such a strategy aggressively exploits opportunities for cost reduction through economies of scale and cumulative learning (experience effects) in purchasing and manufacturing and generally calls for proportionately low expenditures on R&D, marketing, and overhead. Cost leaders generally charge less for their products and services than rivals and aim for a substantial share of the market by appealing primarily to budget-sensitive customers. Their low prices serve as an entry barrier to potential competitors. As long as they maintain their relative cost advantage, cost leaders can maintain a defensible position in the marketplace.

With a more narrow scope, a low-cost strategy is based on focus with low cost. As with any focus strategy, a small, well-defined market niche—a particular group of customers or geographic region—is selected to the exclusion of others. Then, in the case of cost focus, only activities directly relevant to serving that niche are undertaken, at the lowest possible cost.

Southwest Airlines is renowned for its cost-focus strategy. A low-fare carrier that has the highest-profit margins in the airline industry, Southwest Airlines grew 4,048 percent in the 1990s. Its low-cost, no-frills strategy has been highly successful in the U.S. domestic market.

The cost-focus strategy is based on a narrow scope, with a small, well-defined market niche. Southwest concentrates on short-haul routes with high traffic densities and offers frequent flights throughout the day. Efficiency has been improved by eliminating costs associated with “hub” routes involving large major U.S. airports. Southwest limits the number of U.S. states and cities of operation, and it targets secondary airports because of their lower cost structures.

Southwest’s fundamentally different operating structure allows it to charge lower fares than more established airlines. A typical flight, which lasts 1 hour on average, has no assigned seats; in-flight service consists of drinks and snacks only, and the company does not offer transfer of luggage to other airlines.

Southwest’s fleet consists of 284 Boeing 737s, which make more than 3,510 flights per day. Having one type of aircraft allows for greater efficiency and easier turnarounds. All Southwest 737s use the same equipment, thereby keeping training and maintenance costs down. Finally, high-asset use, reflected in a turnaround time averaging 20 minutes, which is less than half the industry average, reduces its operating expenses by 25 percent.

The recession of 2007–2009 caused many companies to abandon their growth strategies in favor of a multiyear cost reduction strategy that could improve their survival odds. Because of successful cost cutting at Gap, its shares increased 27 percent in 2008 because of increased profits on declining revenues. Gap’s cost savings were achieved through reduced inventory levels and the sell-off of noncore assets such as selected real estate holdings.

Similarly, in the face of sharply declining revenues, Dell undertook cost cutting in 2008, including massive layoffs that totaled 11,000 employees for the year and an aggressive plan to sell its manufacturing facilities worldwide.

Although many firms find it possible to maintain some level of profit by cost cutting for as long as one full year, aggressive cost-cutters must eventually find ways to increase their revenues. Circuit City and Radio Shack cut costs and increased profit margins in 2008, but were undone by sharp declines in their revenues. Circuit City filed for bankruptcy in November 2008, the day after it announced that it would close 155 retail stores, and Radio Shack lost 50 percent of its market value in that year.

Differentiation postures can also be tied to decisions of scope. A differentiation strategy aimed at a broad, mass market seeks to create uniqueness on an industry-wide basis. Walt Disney Productions and Nike are examples. Broad-scale differentiation can be achieved through product design, brand image, technology, distribution, service, or a combination of these elements. Finally, like cost focus, a focus with differentiated strategy is aimed at a well-defined segment of the market and target customers willing to pay for value added.

Requirements for Success

The two generic routes—low cost and differentiation—are fundamentally different. Achieving cost leadership requires a ruthless devotion to minimizing costs through continuous improvement in manufacturing, process engineering, and other cost-reducing strategies. Scale and scope effects must be leveraged in all aspects of the value creation process—in the design of products and services, purchasing practices, and distribution. In addition, achieving and sustaining cost leadership require tight control and an organizational structure and incentive system supportive of a cost-focused discipline.

Differentiation requires an altogether different approach. Here, the concern is for value added. Differentiation has multiple objectives. The primary objective is to redefine the rules by which customers arrive at their purchase decisions by offering something unique that is valuable. In doing so, companies also seek to erect barriers to imitation. Differentiation strategies are often misunderstood; “spray painting the product green” is not differentiation. Differentiation is a strategic choice to provide something of value to the customer other than a low price. One way to differentiate a product or service is to add functionality. However, many other, sometimes more effective, ways to differentiate are possible. R&D aimed at enhancing product quality and durability (Maytag) is a viable element of a differentiation strategy. Investing in brand equity (Coca-Cola) and pioneering new ways of distribution (Avon Cosmetics) are others.

Considerable evidence suggests that the most successful differentiation strategies involve multiple sources of differentiation. Higher-quality raw materials, unique product design, manufacturing that is more reliable, superior marketing and distribution programs, and quicker service all contribute to set a company’s offering apart from rival products. The use of more than one source of differentiation makes it harder for competitors to imitate a company’s competitive advantage effectively. In addition to using multiple sources, integrating the different dimensions of value added—functionality, and economic and psychological values—is critical. Effective differentiation thus requires explicit decisions about how much value to add, where to add such value, and how to communicate such added value to the customer. Critically for the firm, customers must be willing to pay a premium relative to the cost of achieving the differentiation. Therefore, successful differentiation requires the thorough understanding of what customers value, the relative importance they attach to the satisfaction of their needs and wants, and how much they are willing to pay.

Risks

Each generic posture carries unique risks. Cost leaders must concern themselves with technological change that can nullify past investments in scale economics or accumulated learning. In an increasingly global economy, firms that rely on cost leadership are particularly vulnerable to new entrants from other parts of the world that can take advantage of even lower factor costs. The biggest challenge to differentiators is imitation. Imitation narrows actual and perceived differentiation. If this occurs, buyers might change their minds about what constitutes differentiation and then change their loyalties and preferences.

The goal of each strategic generic posture is to create sustainability. For cost leaders, sustainability requires continually improving efficiency, looking for less expensive sources of supply, and seeking ways to reduce manufacturing and distribution costs. For differentiators, sustainability requires the firm to erect barriers to entry around their dimensions of uniqueness, to use multiple sources of differentiation, and to create switching costs for customers. Organizationally, a differentiation strategy calls for strong coordination among R&D, product development and marketing, and incentives aimed at value creation and creativity.

Critique of Porter’s Generic Strategies

Generic strategies are not always viable. Low-cost strategies are less effective when low cost is the industry norm, and most executives reject Porter’s generic strategies in favor of strategies that combine elements of cost leadership, differentiation, and flexibility to meet customer needs.¹⁰

The most common arguments against Porter’s generic strategies are that low-cost production and differentiation are not mutually exclusive and that when they can exist together in a firm’s strategy, they result in sustained profitability.¹¹ The preconditions for a cost leadership strategy stem from the industry’s structure, whereas the preconditions for differentiation stem from customer tastes. Because these two factors are independent, the opportunity for a firm to pursue both cost leadership and differentiation strategies should always be considered.

In fact, differentiation can permit a firm to attain a low-cost position. For example, expenditures to differentiate a product can increase demand by creating loyalty, which decreases the price elasticity for the product. Such actions can also broaden product appeal, enabling the firm to increase market share at a given price, and increases its volume sold. Differentiation initially increases unit cost. However, the firm can reduce unit cost in the long run if costs fall due to learning economies, economies of scale, and economies of scope. Conversely, the savings generated from low-cost production permit a firm to increase spending on marketing, service, and product enhancement, thereby producing differentiation.

Finally, the possibility of providing both improved quality and lower costs exists within the total quality management framework. High quality and high productivity are complementary, and low quality is associated with higher costs. 

Value Disciplines

“Value disciplines” is a term coined by Michael Treacy and Fred Wiersema to describe different ways companies can create value for customers. Specifically, they are three strategic priorities: product leadership, operational excellence, and customer intimacy.¹²

Product Leadership

Companies pursuing product leadership produce a continuous stream of state-of-the-art products and services. Such companies are innovation driven, and they constantly raise the bar for competitors by offering more value and better solutions.

The product leadership discipline is based on the following four principles:

Examples of companies that use product leadership as a cornerstone of their strategies include Intel, Apple, and Nike. 

Operational Excellence

Operational excellence—the second value discipline—describes a strategic approach aimed at better production and delivery mechanisms. Walmart, American Airlines, FedEx, and Starwood Hotels & Resorts Worldwide all pursue operational excellence.

Starwood is one of the largest hotel chains in the world with 742 establishments in 80 countries, including famous brands such as Sheraton, Westin, Four Points, and St. Regis. Following an extended period of subpar performance, the company decided to stylishly renovate its underperforming hotels and focus on doing and presenting everything it already did, much better.

The firm’s biggest changes were made to the Sheraton hotel chain, which underwent a $750 million makeover. This renovation was undertaken to restore a reputation for reliability, value, and consistency. The revamping did away with flowered bedspreads in favor of a Ralph Lauren style. Amenities such as ergonomic desk chairs and two-line telephones became standard.

Much of Starwood’s Four Points brand underwent renovations with as much as 80 percent of the original hotel structure torn down. Every room was redesigned and redecorated. Twenty-four-hour fitness facilities were opened. Olympic-sized heated swimming pools with outdoor reception areas became standard. Business centers were expanded to include ballrooms and meeting rooms to accommodate groups of all sizes. Management expanded dining options to range from restaurants to pubs. Guestroom hallways and lobbies were brightened and dramatically redesigned in a subtle, Mediterranean style. Wallpaper borders, sconce lighting, and artful signage were added to present the hotel with a bright fresh look.

Starwood’s focus on operational excellence was immediately successful. For the four straight quarters following the activation of the changes, Starwood led Marriott and Hilton in North American revenue per available room. Operating income increased 26 percent.

Customer Intimacy

A strategy based on customer intimacy concentrates on building customer loyalty. Nordstrom and Home Depot continually tailor their products and services to changing customer needs. Pursuing customer intimacy can be expensive, but the long-term benefits of a loyal clientele can pay off handsomely.

Because the vast majority of companies worldwide now claim to give top priority to customer concerns, it might be hard to imagine how a firm distinguishes itself through customer intimacy. Home Depot provides an excellent example of a firm that succeeds. It uses customer intimacy initiatives to marginalize competitors. The company’s plan began with the creation of its “Service Performance Initiative,” which emphasizes changing daily operations to provide a more shopper-friendly store atmosphere. Home Depot added off-hour stocking, which moves merchandise in and out of inventory during late evening hours or after closing for those stores that have not expanded their operating hours to 24 hours per day.

The main benefit of the new stocking method is the ability of employees to focus on customer service and sales. Before the implementation of the initiative, salespeople spent 40 percent of their time with customers and 60 percent on other work-related duties. After the customer intimacy initiatives, salespeople were able to spend 70 percent of their time with customers on sales-oriented tasks and 30 percent on other duties.

Home Depot undertook two additional customer intimacy initiatives. The first was the installation of Linux Info for point-of-sale support systems. With the new system, customers can place orders from home over the Internet and have the purchase processed at the store’s register. This process allows customers to enter the store simply for pickup, having already purchased their merchandise. The second initiative involves home improvement classes taught at its stores. Customer intimacy is enhanced when professionals teach customers how to buy and install the proper materials and construction equipment. Home Depot sells products and receives customer feedback as outcomes of the courses.

Most companies try to excel in one of the three value disciplines and be competitive in the others. Explicitly choosing a value discipline and focusing available resources on creating a gap between the company and its immediate competitors with regard to the discipline sharpens a company’s strategic focus.

Designing a Profitable Business Model

Designing a profitable business model is a critical part of formulating a business unit strategy. Creating an effective model requires a clear understanding of how the firm will generate profits and the strategic actions it must take to succeed over the long term.

Adrian Slywotzky and David Morrison have identified 22 business models—designs that generate profits in a unique way.¹³ They present these models as examples, believing that others do or can exist. The authors also confirm that in some instances profitability depends on the interplay of two or more business models.

What is our business model? How do we make a profit? Slywotzky and Morrison suggest that these are the two most productive questions asked of executives. The classic strategy rule suggested that, “Gain market share and profits will follow.” This approach once worked for most industries. However, because of competitive turbulence caused by globalization and rapid technological advancements, the once popular belief in a strong correlation between market share and profitability has collapsed in many industries.

How can businesses earn sustainable profits? The answer is found by analyzing the following questions: Where will the firm be able to make a profit in this industry? How should the business model be designed so that the firm will be profitable?

Slywotzky and Morrison describe the following profitability business models as ways to answer these questions: