Business Strategy and Business Model: Extending the Strategy

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  • 1.Business Strategy and Business Model: Extending the Strategy-Structure-Performance ParadigmbyC. Zott and R. Amit 2004/84/ENT/SM/ACGRD 8Working Paper SeriesINSEAD-Wharton Alliance Center for Global Research & Development

2. Business Strategy and Business Model: Extending the Strategy-Structure-Performance Paradigm*Christoph Zott INSEAD Euro-Asia Center 006Boulevard de Constance 77305 Fontainebleau CedexFRANCE Telephone: 33 1 6072 4364 Fax: 33 1 60 72 42 23E-mail: christoph.zott@insead.eduRaphael AmitThe Wharton School University of Pennsylvania3620 Locust walkPhiladelphia, PA 19104-6370 Telephone: (215) 898-7731Fax: (215) 573-7189E-Mail: 6 August 2004 * Both authors contributed equally to this article. We gratefully acknowledge the financial support of the Wharton-INSEAD Alliance Center for Global Research & Development. Christoph Zott acknowledges support from the Rudolf and Valeria Maag Fellowship in Entrepreneurship at INSEAD. Raffi Amit acknowledges financial support from the Wharton e-business Research Center (a unit of WeBI) and the Robert B. Goergen Chair in Entrepreneurship at the Wharton School. We thank Iwona Bancerek, Amee Kamdar, Jenny Koelle and Gueram Sargsyan for valuable research assistance. 3. Business Strategy and Business Model:Extending the Strategy-Structure-Performance ParadigmABSTRACTWe extend the strategy-structure-performance paradigm to highlight the interdependencies among afirms product market strategy, the structure of transactions it enables with external stakeholders (itsbusiness model), and its performance. By developing a formal model, we are able to examinetheoretically the contingent effects of product market strategy and business model design on firmperformance. Using a unique manually collected data set, we find that novelty-centered businessmodel design, coupled with product market strategies that emphasize differentiation, cost leadership,or early market entry, enhances firm performance. KEYWORDS: Product market strategy, business model, performance, strategy-structure- performance paradigm, competitive strategy. 2 4. Business Strategy and Business Model: Extending the Strategy-Structure-Performance ParadigmThe Strategy-Structure-Performance (SSP) paradigm addresses linkages between corporatestrategy (e.g., the extent of diversification) and administrative structure (e.g., divisional versusfunctional forms) of firms (Chandler 1962). In this paper, we extend this paradigm by examining theinteraction between a firms product-market positioning choices and its business model design, whichcenters on the architecture of the firms transactions with external stakeholders. While research on theSSP paradigm has focused largely on the administrative structure of a firm within its boundaries, weare concerned with structures as architectural designs of transactions that span firm and industryboundaries. Specifically, we ask if business model design is distinct from a firms product-marketpositioning and how product market strategies and business model designs interact to affect firmperformance.Consider, for example, the case of Inc., a provider of an electronic pricingsystem, known as a demand collection system. Using the internet, it enables consumers to save moneyon a wide range of products and services by trading flexibility regarding brands, product features,timing, convenience and/or sellers in return for being able to buy products and services at prices thatare lower than those charged through traditional retail distribution channels. Further, Priceline enablessellers to generate incremental revenue by disposing of excess inventory or capacity at prices that arelower than the ones they offer through other channels while protecting their brand. Overall then, theproduct-market strategy of Priceline is cost leadership. However, Priceline's business model is novel,and thus innovative. At its core is a reverse market auction pricing mechanism for which the companyhas secured a business method patent. It allows the customer to name the price at which they wish totransact and the company will attempt to find a provider of the product or service within a specified3 5. range. So how does the cost leadership product market strategy of Priceline interact with its novelty-centered business model design to affect its performance? Is there fit among these constructs?By developing a formal model, we examine theoretically the interdependencies among salientdimensions of product market strategy, different business model design themes, and firmperformance, thereby answering these questions. Using our unique data set on business strategy andbusiness models, we establish empirically that a firms product market strategy and the design of afirms business model are distinct constructs that individually and jointly affect firm performance.Specifically, we find that novelty-centered business model design, coupled either with adifferentiation or cost leadership strategy, enhances firm performance. In addition, we ascertain that anovelty-centered business model design joined with early entry into a market positively affectsperformance.This study attempts to make the following contributions: First, it extends the perspective ofthe SSP paradigm on structure, from being concerned with the administrative structure of the firm to afocus on the architectural structure of transactions the focal firm enables with external stakeholders.As well, the study shifts the focus of the SSP paradigm from corporate to business strategy. Second,in this paper we argue theoretically, and validate empirically that the business model construct is validand distinct from received notions of a firms product market strategy. Third, we offer a formal modelthat allows us to articulate how interactions among our main constructs are expected to affect firmperformance. Fourth, we test these theoretical developments empirically, and show that novelbusiness model design can augment the competitive advantage realized through superior productmarket strategy. In other words, both product market strategy and structure as embodied by the designof the business model can enhance the firms competitive advantage, independently as well as jointly.The remainder of the paper is organized as follows: We proceed in the next section to presentour theory and model, after which we explain the data and methods we used to test it. We then presentour results, and we conclude with a discussion of our findings and implications for future research.4 6. THEORYStrategy and StructureIn his study of large American corporations and their approaches toward product-marketdiversification, Alfred Chandler (1962) observed that major increases in volume, geographicdispersion, and vertical and horizontal integration of firms were followed by changes in theiradministrative activity, which eventually led to the emergence of the M-form of organization. Thatline of reasoning, however, provoked the counterargument that strategy follows structure" (e.g.,Bower 1970), which was predicated on the logic that managerial cognition and skills mediate betweenstructure and strategy. The ensuing debate in the strategy literature on the relationship betweenstrategy, structure, and firm performance known as the SSP debate flourished in the 1970s and1980s, but (with few exceptions, e.g., Amburgey and Dacin 1994 and Yin and Zajac 2004) seems tohave received less attention recently.Some management scholars have pointed to the relatively narrow focus of the traditional SSPdebate on corporate strategy and administrative firm structures, which might limit the applicability ofSSP theory to large, established corporations, and which might also explain why some researchersseem to consider the subject as settled. However, there might be much more to the concepts of bothstrategy and structure (Miller 1986: 233). In this paper, we propose to reopen -- and enrich -- the SSPdebate by examining business strategy instead of corporate strategy, and by focusing on the firmsbusiness model instead of its administrative structures.In terms of business strategy, we focus on some salient aspects of a firms product marketstrategy. We view product market strategy as the way in which a firm chooses to build, exploit, andsafeguard advantages in its addressable market spaces by making the following decisions: (1) Whattype of product market positioning approach to adopt (i.e., cost leadership and/or product/servicedifferentiation; see Porter 1985); and (2) When to enter the market (Lieberman and Montgomery1988). The answers to these questions are central to our understanding of how firms that operate incompetitive product markets create and appropriate value.5 7. Towards a New Perspective on StructureThe received literature on the strategy-structure debate has focused on administrativestructures within firm boundaries, and paid little attention to extending the question ofstrategy/structure fit issues for other structural forms of organization (Yin and Zajac 2004: 365). Yet,rapid advances in information and communication technologies have enabled new types oftechnology-mediated interactions between economic agents (Geoffrion and Krishnan 2003). Inparticular, such new information technologies as the internet and broadband wire- and wirelesscommunication technologies have facilitated the design of novel architectures of economicexchanges, thus enabling firms to change fundamentally the way they organize and transact, bothwithin and across firm and industry boundaries (Mendelson 2000). Consequently, new opportunitieshave emerged for the creation of organizational arrangements among firms, partners, and customers.On-line communities for open source software development are a case in point (Lee and Cole 2003).These developments have facilitated a shift in the locus of value creation beyond theboundaries of the firm (Gulati, Nohira and Zaheer 2000; No