What business are you in? How do you create value? How do you want to create value? Understanding the logic of value creation in your business allows you to understand how to survive and thrive in your ecosystem.
Research in business and management suggests there are three kinds of business, namely product, service and platform business. Each has its own value creation logic. Fifty years of research has not resulted in any additional kind of business, so I assume this is it.[i] In this briefing I describe the value creation logic of these three kinds of business.
Product value creation logic
Manufacturers produce tangible products following Porter’s value chain:
- Inbound logistics,
- outbound logistics,
- marketing & sales,
- after-sales service.
This model is also applicable to the production of software products.
Manufacturing can be further subdivided into subtypes such as mass-produced standardized production and individual customized production, which come with different levels of automation.
Up until the 1980s, the logic of value chains was to reduce uncertainty about the environment by vertically integrating all activities in the value chain. Today, by contrast, product businesses have created extended enterprises, which are networks of partners with which they have agreements about value creation tasks. Logistics, production, marketing and sales may all be partly or wholly outsourced to partners who can perform these tasks efficiently.
The profit model of product businesses is traditionally based on transfer of ownership of the product, where price may be determined by external conditions such as the level of demand, and revenue may be shared with partners. Cost is managed by exploiting economies of scale and utilizing all capacity. Today, new business models have appeared where a product is not sold but the service delivered by the product is sold. This means that profit models common in the service industry are used.
Service value creation logic
Service provision has a quite different value creation logic which goes by many names but which I will here call the problem-solving cycle, because a service provider must help a customer solve a problem. Administrative service providers, housekeeping services, taxi drivers, engineers, architects, lawyers, physicians and all other service providers help their clients achieve a goal, which is to say that they help their clients solve a problem. The value creation logic is the problem-solving cycle:
- problem finding (which includes service marketing and sales),
- problem analysis,
- service design and validation,
- service provision,
- service evaluation.
For routine services, the problem-solving part of this cycle (problem analysis and service design and validation) is negligible. Administrative service providers, housekeeping services and taxi drivers quickly know what to do when they find a client. Other service providers require expert problem-solving competence, such as architects, engineers and lawyers.
Like product businesses, service businesses too may create a network of partners that perform parts of the problem-solving cycle. Businesses may specialize in one task of the problem-solving cycle in their domain, such as diagnosis or solution design, and create a partnership to solve a problem for a particular client.
The profit model of service businesses is always based on transfer of the right to a service. The price may be based on usage of the service, transaction fees or service performance and may include a base fee in the form of a subscription or membership. Competitive advantage of expert problem solving is based on delivering high quality. Cost is less important. In general, service providers want to build up a reputation of high quality.
Platform value creation logic
All businesses live in an ecosystem of partners, clients, suppliers, competitors, regulators, professional organizations, malicious agents and many more, in which they try to survive and thrive. In other words, all businesses are enabled by ecosystems. Outside this ecosystem they would wither and die.
There are also businesses that enable an ecosystem, i.e. create one where there was no ecosystem before. These are platform businesses, which provide an infrastructure used by all members of an ecosystem.
As I explained in an earlier briefing, there are two kinds of platform businesses. Layer platforms provide an abstraction on top of which other members of the ecosystem can create value-adding services. Examples are operating systems, game platforms, and IoT platforms.
Interaction platforms provide communication and coordination services to the members of an ecosystem, such as search, communication, matchmaking, transacting, payment and evaluation. Examples are social networks and ride-haling platforms, but also old-fashioned shopping malls, which connect shops and consumers, and real-estate brokers.
Both kinds of platform business models have the same value creation logic, which we call the ecosystem enabling logic:
- platform design, construction & maintenance,
- service provision,
- marketing and sales,
- ecosystem governance (e.g. gatekeeping of participants, curation of content).
Platforms manage a dynamic network somewhat similar to what club managers do. They monitor entry and exit of participants in their ecosystem and facilitate the creation of relations and joint activities among participants. Governance of the ecosystem that they enable is a crucial activity of platforms.
Platforms have similar pricing schemes as service providers,
but matching platforms have a special problem, namely that they must design a
pricing scheme for two or more sides of the platform. Often, one side is
subsidized (for example, the user of a social platform) and another side must
pay (for example, the advertisers on a social platform). Platforms often start
out giving their service away, until a critical mass is reached at which positive
network effects occur. Like product businesses, they want to achieve economies
of scale and utilize their capacity.
[i] In 1967, James Thomson distinguished three kinds of technology that he used to classify organizations, which he called long-linked technology (for sequential production), intensive technology (for intensive customer interaction), and mediating technology (for mediation among customers). Stabell & Fjelstad used this classification to analyse strategic options in competitive analysis of Porter’s value chain (with long-linked technology), value shops (using intensive technology) and value networks (using mediating technology). Recently, Johnson used this typology to define three archetype business models that can be the starting point for business model transformation. I adapted the classification of Barnell & Fjelstad by expanding their value shop (which provide expert services) with routine services, and renaming their value networks into platforms, which, in modern terminology, is what they meant.
Mark W. Johnson. Reinvent Your Business Model. Harvard Business Review Press, 2018.
Charles B. Stabell and Øystein D. Fjeldstad. “Configuring value for competitive advantage: on chains, shops, and networks”. Strategic Management Journal, Vol. 19, 413-437 (1998).
James D. Thompson. Organizations in Action. McGraw-Hill 1967, Transaction Publishers, 2003.