Business and operating models

Yesterday I was facilitating the Chartered Institute of Personnel and Development Organization Design progam. One of the attendees asked what the difference is between a business model and an operating model is and where organization design fits into either. That's a good question. A couple of years ago I taught a 12 week course on the California College of the Arts Design Strategy MBA on Business Models and Stakeholders.

I started that course with the question 'what is a business model'. Harvard Business School (case study number 9-708-452, revised June 23 2008) has a module, Competing Through Business Models that answers the question, making the point that:

'while the expression 'business model' has been part of the business jargon for a long time, there is no widely accepted definition of what it means. Its origins can be traced back to the writings of Peter Drucker but the notion has gained prominence amongst both academicians and practitioners only in the last decade'

The authors of the case propose a definition of a business model:

A business model comprises i) a set of choices and ii) the set of consequences derived from those choices.

And suggest that 'it is useful to distinguish different types of choices and consequences. Choices are around policies, assets, and governance. Consequences are rigid or flexible.

Alexander Osterwalder, a consultant on business models, who wrote a paper 'How to describe and improve your business model to compete better has a similar view of what a business model suggesting that it is – the 'what and how' of a business.

'The business model of a company is a simplified representation of its business logic. It describes what a company offers its customers, how it reaches them and relates to them, through which resources, activities and partners it achieves this and finally, how it earns money'.

In a sense a business model is what someone seeking investor support to set up a company would describe in the business plan.

So, although two companies, for example two banks, may be in the same industry, compete in similar markets and appear to have similar cultures, they are almost certain to have different business models and it is this business model differences that in part accounts for them having different success levels. (The business exists in relation to the environment in which it is situated, and is not a self-contained system. It is subject to social, environmental, cultural, and economic influences coming from outside its 'borders').

Like the Harvard Business School, Osterwalder presents a graphic of a business model where boxes represent the 'what' of the organisation and require conscious choices and decisions to be made for each of them, for example the box 'competences, activities, and resources' requires choices and decisions around questions like "What are the main activities we operate to run our business model? On which key resources do they rely? To which value propositions, channels or relationships do they contribute?"

The arrows between the boxes represent the 'how' of the organisation and include both 'hard' things like IT systems or explicit policies, and 'soft' things like leadership style or speed of decision making. Again organisational members make choices and decisions around these. For example, the arrow from 'customer relationship' to 'offer' requires choices and decisions around soft questions like "How responsive will we be to customer feedback? Are we going to 'tell' the customer or are we going to make choices and decision by involving the customer? Will we treat all customers equally?' and to hard questions like 'What IT system is the best customer relationship management system for our purposes', 'What packaging shall we offer our product in? What price point should we offer at?"

Each of the choices and decisions made have consequences that make for, or sustain, business model viability. As the example of Domino's Pizza illustrates. In July 2009 Domino's reported that international same store sales (sales revenues of retail stores that have been open for a year or more) grew 4.1%. The international division continued its strong performance, posting its 62nd consecutive quarter of same store sales growth.

David Brandon, CEO said "I'm putting this quarter in the "win" column for Domino's Pizza. I'm proud of my team and our accomplishment of emerging as a leader during tough times. The predictability of our (business) model continues to be a plus in an unpredictable landscape."

In this case the choice to be 'predictable' yet remain competitive has a number of consequences – one of which is the requirement for continuous improvement.

In my view the business model relates to choices and consequences. The operating model refers to the way the model is 'driven' for example, by structure (relating to things you see on the organization chart), by system (SAP over Oracle), by job design, by skill levels of the workforce, and other elements of the design.

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