Evolution of Business Models: Early 20th Century to Today

Introduction

Business models continue to grow in complexity and in the level of integrative processes that are knowledge- and intelligence-based. From the relatively simple production-based business models of the early 20th century to the highly orchestrated, knowledge-based business models of Toyota — designed to support their global production and supply chain system (Dyer & Nobeoka, 2000) — or Google, with its world-class advertising business model (Pynnonen, Hallikas, & Ritala, 2012), information and intelligence have replaced manufacturing power as the primary source of competitive advantage.

The intent of this analysis is to evaluate the evolution of business models from the early 1900s to today, with specific attention paid to their progression from time-and-motion-based production to highly integrated knowledge networks that seek economies of scale through information. These latter phases of business model development have shifted the focus of entire industries away from a myopic, inward-centric concentration on production metrics to instead place the customer at the center of the business (Pynnonen, Hallikas, & Ritala, 2012). Google credits its success in advertising — and in the many other businesses it operates — to innovating around the customer first, including both businesses and consumers within that definition (Cagliano, Caniato, & Spina, 2005). A business model in its purest form is a taxonomy of how an entity intends to deliver value to its customers (Kujala et al., 2011).

The core components of a business model are first defined in this analysis, followed by an overview of the historical progression of models through to the present day. Following the historical analysis is a comparative table illustrating the similarities and differences of each dominant type of business model.

At their most basic, a business model is a taxonomy that defines how an entity will add value to customers through the transformation of materials, resources, expertise, and knowledge. Studies of business models indicate that their taxonomies over time reflect the relative complexity of the markets they serve and the broadening base of customer expectations they must meet to succeed (Rebelo, 2005). The core elements any complete business model must include are: a definition of the business's core capabilities; a customer value proposition including a clear statement of how the company differs from competitors; a clear definition of the target customer; clarity of the revenue and pricing model; a distribution channel definition; partnership strategies; and cost structure clarity (Linder & Cantrell, 2001; Porter, 1986; Weill & Vitale, 2002).

The Foundational Elements of a Business Model

From the initial business models that were entirely based on production efficiency and driving down per-unit costs through economies of scale and heavy reliance on the build-to-inventory approach, to the highly complex yet very agile business models of mass customization (Pynnonen, Hallikas, & Ritala, 2012), business models have had to strive for agility in order to keep businesses viable and competitive.

The initial business models of the early 1900s were oriented primarily toward manufacturing efficiency and build-to-inventory production, with little focus on the customer or their unique requirements (Pensieroso, 2011). The rise of Alfred P. Sloan as General Manager of General Motors during the early 20th century was a direct result of how well he understood production efficiency-based business models and his strong-minded focus on determining Return on Investment (ROI) for each manufacturing operation (Rebelo, 2005). Sloan became one of the leading executive proponents of build-to-inventory production techniques and also pioneered the idea of a business model capable of supporting highly segmented product lines as GM evolved under his direction (Pensieroso, 2011).

Sloan had set the foundation for a revolution in business models that would unfold in the mid- and late decades of the twentieth century. It became clear that the traditional build-to-inventory and build-to-stock business models — even with his invention of advanced financial metrics including ROI and Return on Assets (ROA) — would not scale to a level of profitability sufficient to deal with the extreme economic fluctuations of the American economy (Pensieroso, 2011). Sloan and his contemporaries through the 1940s and 1950s began experimenting with multi-project-based business models also designed to be agile enough to support multistage and multidivisional requirements (Wikstrom, Artto, Kujala, & Soderlund, 2010). Lessons learned during World War II's production runs — regarding economies of scale, more agile approaches to the specialization of labor, and a focus on lean manufacturing — began to evolve rapidly (Mitchell, 2005). As the U.S. and global economy enjoyed significant economic growth during this period, the need for agility and rapid customization in business models was not yet critical; the economy was sustaining businesses that excelled at delivering quality products with little or no major customization available to customers (Teece, 2010).

Historical Progression of Business Models

In the mid-1970s, Dr. Michael Porter began work on the value chain, a business model concept that would galvanize entire industries and provide a very clear link back to the financial metrics that Alfred P. Sloan had defined as critical, including Return on Invested Capital (ROIC) (Porter, 1986). By the 1980s, value chain-based business models had become dominant, driven by the manufacturing expertise and cost advantages of offshore producers who combined their business models with North American distribution and marketing organizations (Porter, 1986). Value chain-based business models were also responsible for the growth of the semiconductor, high-tech componentry, and many sectors of the high-technology industry, as Japanese and Asian manufacturers embraced and extended many aspects of this framework (Porter, 2001). The ROIC-based extensions of this model gave companies operating within it significant competitive advantage during an era when production efficiency and competing on lowering production costs were critical to market penetration (Rebelo, 2005).

The next generation of business models shifted from being production-centric and focused on efficiency to placing insight, intelligence, and knowledge of the customer at the center (Rebelo, 2005). Corporations' business models had grown extremely large, complex, and cumbersome, and lacked the agility necessary to respond quickly to customers' unique requirements. This led one management theorist to observe that existing corporate business models had excelled so well at minimizing and mitigating risk (Shi & Manning, 2009) that they had forgotten how to serve the customer (Hamel, 2011). The era of the knowledge-enabled business model had begun.

This era was marked by the strategic use of knowledge and information, both within and outside the company. The Toyota Production System (TPS) and its high-performance knowledge-sharing network are a case in point (Dyer & Nobeoka, 2000). This network allowed suppliers external to Toyota to gain real-time insights into customer forecasts and to plan their own production runs accordingly. The high-performance knowledge-sharing network business model also laid the foundation for process re-engineering-based business models, which took the concept of knowledge engineering to the next logical step and began redesigning entire workflows throughout corporations (Hamel, 2011).

With the added speed and performance of processes that had been completely redesigned from the ground up, the next generation of business models — predicated on e-business (Porter, 2001), the e-business design network (Cagliano, Caniato, & Spina, 2005), and business model design with multi-model management (Wirtz, Schilke, & Ullrich, 2010) — organizations were finally able to attain a higher level of agility, customer focus, and the ability to customize products and services in real time to customer requirements (Pynnonen, Hallikas, & Ritala, 2012). In this latest phase, the orientation has changed to reflect more of a market- and customer-driven set of priorities that permeate the entire value chain of a business.

These changes have also re-architected the traditional value chain as originally defined by Dr. Porter (Porter, 1986) nearly three decades ago. No longer static and highly regimented as Dr. Porter initially envisioned it, today's value chains are much more fluid and demand-driven, concentrating on the customer experience and the potential to provide a highly customized offering. This latest generation of business models has provided the foundation for entirely new businesses that were unforeseen even a decade ago, which signals that this is an area of rapid change in new venture development (Kujala et al., 2011).

The following table summarizes the common characteristics, key differences, and contextual comments for each dominant business model type identified in the historical analysis above.

Build-to-Inventory / Build-to-Stock
Common Characteristics: Highly structured, inflexible approach; values stability and does not respond well to customer-driven change.
Differences: Comparable to project-based business models in multiproject and multidivisional structures.
Comments: A very inflexible business model that placed the core focus of activity on internally generated metrics.

Multiproject, Multistage, and Multi-Divisional Models
Common Characteristics: Legacy support from the build-to-inventory model; comparable to the value chain model in terms of Manufacturing Resource Planning.
Differences: Unique approach to project-based manufacturing; nascent design for knowledge-sharing model, later strengthened by the value chain business model phase.
Comments: An outgrowth of World War II and division-of-labor practices being seen as critical to business model success; still lacked agility.

The Value Chain-Based Business Model
Common Characteristics: Dr. Porter's revolutionary model showing the division of functional areas into those that directly deliver profit; fits well into multiproject-based business models.
Differences: Unique in defining the division of labor by functional areas — never previously formalized in this way.
Comments: Immediately accepted because the division of labor set the foundation for adoption; proven to deliver profitability.

High-Performance Knowledge-Sharing Network
Common Characteristics: The most ambitious business model of all, centering on information sharing across an extended enterprise.
Differences: Highly differentiated and unique from any other business model — never before seen at this scale.
Comments: Made the transition to a knowledge-driven economy possible.

Conclusion

The progression of business models has been from those initially focused on the internal needs of a company to the expectations, preferences, wants, and needs of customers. Compounding this transition has been the need to provide customers with highly customized products and experiences (Pynnonen, Hallikas, & Ritala, 2012). These factors have been taken into account in the analysis of the core business models that have dominated the global economic landscape from 1900 to today. The key features of today's business model are defined earlier in this analysis, which also shows how agility and responsiveness have won out over rigidity and cost reduction over time. The need to create business models that remain in step with customers' expectations and needs has never been greater, as businesses face greater uncertainty and risk in their core markets than ever before.