Strategy & Innovation February 17, 2010, 3:33PM EST

When Should You Innovate Your Business Model?

Considering external circumstances and how they impact an existing business will help executives to figure out when (and how) to change direction

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In my book Seizing the White Space: Business Model Innovation for Growth and Renewal, I tried to distill the question of when to innovate your business model into a specific set of circumstances. But it can never be a cookie-cutter exercise. It's always going to come down to judgment and perspective, thinking through the specific situation of your company. There are just too many moving parts to say in perfect confidence, "OK, well, we're in this situation, so we're going to fundamentally change our business model, and we need to set up a separate business unit." It doesn't work that way.

What I suggest in the book is that strategists need to think first about the external circumstances and then about what you may or may not need to change in your company. This thought process will help you decide if what you're talking about is fundamental business model change.

So, what are the external circumstances that might suggest it's time to innovate your business model? They can be grouped into threats and opportunities.

External Circumstances: Threats

First, there are two basic threats to the incumbent business that require the business model to be changed. Or, as Peter Drucker would say, times when "the theory of the business is no longer working."

One of those threats is the process of commoditization. Generally speaking, industries go through a fairly predictable progression, in which the basis of competition moves from performance—making the better widget—to reliability—that is, making that widget more reliable, longer-lasting, and more durable— to customization and convenience—making multiple different widgets and making them more convenient and customized for individual tastes—to, eventually when all of that's said and done, pure commoditization, when everyone's competing only on price and cost.

In the evolution of that lifecycle, business model innovation starts to play a role at the point when you get to customization and convenience, and is fairly imperative as a way to escape commoditization. A great example of the convenience play is Dell Computer (DELL), which came into the personal computer market and said, "We're going to make a play for convenience and customization" and introduced a fundamentally different direct-to-customer, manufacture-just-what-the-customer wants business model to the personal computer industry.

Xiameter is a good example of escaping the profit-killing effects of commoditization. Dow Corning, longtime maker of high-end silicon products sold through a high-margin, high-touch business model, created a whole new business called Xiameter to address decreasing demand for technical support among some segments of its customer base. Rather than cede those customers away to a competitor, it created a radically different business model in which it lowered costs, not only by stripping away support (which would just lower its margins) but by sourcing its product on the spot market, thus dynamically lowering its costs.

The point is two-fold; Xiameter didn't try to address this new customer need by shoehorning it into its existing model, which would never have worked. And it didn't put its head in the sand and say, "Well, we can't serve those customers profitably, so we won't, and we hope no other competitor does either."

Classic disruption is the second threat to the business that would require a new business model. Take the classic case of the old integrated steel mills when they confronted a disruptive threat from small minimills, which had worked out a way to produce lesser-grade steel at far lower cost. The big, integrated mills had two choices. They could either have passed along all that low-cost business to the minimills (which is, in fact, what they did), or they could have said, "Well, we're being disrupted, so let's come up with a whole new business model to address that." If they had gone with option two, they might have survived when the minimills improved their quality and ate up the entire customer base from the bottom up.