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Chapter 1
Modeling Business Strategy
Introduction
A strategic business model is an important and basic technique for business strategy. A four-factor strategic model emphasizes the fundamental factors in any business: capital, profits, resources, and sales. And an open-system strategic model places the model within the future environment of the business.
Strategic Business Models
Business organizations are goal-directed and create transformations to reach goals, as an enterprise system. As shown in Fig. 1.1, an enterprise system is an open-system, transforming inputs of resources to outputs of product sales. Also shown in the figure is Michael Porter’s model of a goal-directed transformation, shown as a kind of “arrow” (Porter, 1981).
For a production enterprise, the system consists of the coordinated set of productive activities (purchasing, production, inventory) which adds value to resources purchased from the market environment and then sold back into the market as products. Porter’s model adds overhead functions to the direct production (transformation) center of the open-system model.
In this two-factor model, resources and sales provide two basic factors for the direct production transformations of a business operation. But there are also two other basic factors, profits and capital, that are necessary to an enterprise system. These indicate the factors needed for adding monetary-value in business operations. Profit is a measure of business efficiency (the difference between prices and costs of sold products/services). Capital is a measure of the asset value of the business, equity as the stock value. Using these, a more general form of business models was constructed as a four-factor model (Betz, 2015).
To construct a strategic business model of any enterprise, one can use the four factors either as inputs or outputs: resources, sales, profits, and capital. How many types of “business models” can be constructed? Logically, one can list all possible (two by two types of enterprise open-systems) by taking all combinations of the four categories (resources, sales, profits, capital) two-at-a-time as inputs and as outputs. Ignoring the order of factors in a combination, one can construct six different models to describe a business, as shown in Fig. 1.2.
Fig. 1.1: Porter’s Value-added Open System Model.
The upper box lists the four strategic factors which can be used to construct a strategic business model. The lower box takes them two at a time, as either inputs or outputs, and lists their six logical combinations (ignoring the order of the factors in a combination). The oval depicts the environment for a strategic business model with two inputs and two outputs. Fig. 1.3 sketches the six different forms of strategic business factors.
Fig. 1.2: Two Inputs and Two Outputs Strategic Business Models.
Fig. 1.3: Six Types of Strategic Business Models.
Type 1 model corresponds to Porter’s value-added transformation model, with the addition of invested capital as a second input and profits as a second output. (We note that logically one can construct 1 × 3 models, but these are empirically less interesting than the 2 × 2 models, shown in Fig. 1.3.)
A business model depicts the operations of a current business in its present competitive situation, and a strategic business model depicts the future operations of the business to face an anticipated future competitive situation. Strategic business models focus strategic change (1) to meet future challenges and (2) to optimize performance measures in the future. Management should focus not only upon successful operation of the present (e.g., current quarter) but also upon preparing now to meet the future challenges (e.g., 2–10 years).
Strategic business models examine whether the present “core ideas” of a business will continue to be viable in the future. About core ideas, Lowell Steele wrote:
Every business is based ultimately on a few simple ideas, principles, or even assumptions. They address the fundamentals of the business: What products or services do we provide? Who are our customers? How do we compete? How do we define success? How do we behave toward each other? In the aggregate these fundamental features could be termed the concept of the enterprise. (Steele, 1988)
Strategic business models examine such basic assumptions – the fundamentals of a business – as sustainable in the future.
Core ideas are embedded in the “culture” of a firm. Steele emphasized that a business’s answers to the fundamental questions of the enterprise is implicit in the shared beliefs and conventions in the culture of the firm. From the experience in successful business operations, managers developed have developed a “business culture” – a culture of shared beliefs and conventions about how the firm should operate, including assumptions about: (1) the nature of the business, (2) the way competitive advantages are gained, (3) a sense of how and why the company became what it is, and (4) conventions about the guidance and operational control of the enterprise. These kinds of issues provide what Steele called the “basics” of a business enterprise. Strategic business models should address the validity of the shared beliefs and conventions of a business, as continuing into the future.
Case Study: Amazon Acquires Wholefoods in 2017
First, we use this analysis of strategic models to better understand the strategic differences between Amazon and Whole Foods. In 2017, an example of the need for different types of strategic business models occurred when the Internet firm of Amazon acquired the brick-and-mortar firm, Whole Foods. In this case, the form of a strategic business model for Amazon differs from one for Whole Foods.
Nick Wingfield and Michael J. de la Merced wrote,
Amazon agreed to buy the upscale grocery chain Whole Foods for $13.4 billion, in a deal that will instantly transform the company that pioneered online shopping into a merchant with physical outposts in hundreds of neighborhoods across the country. The acquisition, announced Friday (June 14, 2017), is a reflection of both the sheer magnitude of the grocery business – about $800 billion in annual spending in the United States – and a desire to turn Amazon into a more frequent shopping habit by becoming a bigger player in food and beverages. After almost a decade selling groceries online, Amazon has failed to make a major dent on its own, as consumers have shown a stubborn urge to buy items like fruits, vegetables and meat in person. (Wingfield & Merced, 2017)
Amazon was one of the first successful Internet retail businesses, beginning by selling books and then expanding into selling many kinds of products, such as music or electronics. Amazon built distribution facilities and purchased products, selling and delivering them to customers, who ordered “online.” The acquisition of Whole Foods moved Amazon into running a brick-and-mortar business (wherein customers could walk into a building, select and buy groceries – or, as Amazon planned, order groceries online, and have the groceries delivered).
Wingfield and de la Merced wrote,
Buying Whole Foods also represents a major escalation in the company’s long-running battle with Walmart, the largest grocery retailer in the United States, which has been struggling to play catch-up in Internet shopping. On Friday, Walmart announced a $310 million deal to acquire the Internet apparel retailer Bonobos, and last year it agreed to pay $3.3 billion for Jet.com and put Jet’s chief executive, Marc Lore, in charge of Walmart’s overall e-commerce business. “Make no mistake, Walmart under no circumstances can lose the grocery wars to Amazon,” said Brittain Ladd, a strategy and supply chain consultant who formerly worked with Amazon on its grocery business. “If Walmart loses the grocery battle to Amazon, they have no chance of ever dethroning Amazon as the largest e-commerce player in the world.” (Wingfield & Merced, 2017)
Strategic Business Models: Whole Foods and Amazon
How can one model the business of Amazon and the business of Whole Foods? They must be different models, because Whole Foods is a production-type firm (a retail firm – buying packaged food products and selling these to customers). And, in contrast, Amazon is a conglomerate firm (owning several businesses, including: Amazon’s online retailing business and also Whole Foods’ grocery business). This case of Amazon’s Internet expansion into multiple productive businesses illustrates the need for a complete set of strategic models (including one to depict a conglomerated corporation). While the traditional Porter value-adding business model can depict a single business, such as Whole Foods, it cannot depict the strategy of a diversified corporation, such as Amazon.
Fig. 1.4: Comparing Business Models for Whole Foods and for Amazon.
Whole Foods acquires food resources from food producers and distributes these (transforming by distribution) to retail grocery stores for sale to customers in the food market (commodity market environment). Fig. 1.4 shows the analysis of the strategy of this kind of productive business in a four-factor model. Food resources is an input from the agricultural markets, and sales of packaged foods is an output to the customers in the groceries market. Capital was used to build stores and purchase equipment and inventory and is an input to the grocery enterprise system. Profits of sales from grocery operations is an output of the enterprise. A production system (such as manufacturing or retailing) can be depicted as Porter value added, transformative system, but with the capital also as an input and profits an output.
But this “production-system” model does not match the reality of Amazon. Fig. 1.4 also depicts Amazon, but as a conglomerate. Amazon is a holding company which owns other businesses, including Whole Foods.
As a conglomerate, Amazon takes profits and sales from its portfolio businesses (such as Whole Food) as inputs and produces outputs as resources and capital. Amazon’s portfolio businesses report their sales and profits to the conglomerate Amazon’s “bottom-line” (balance sheet). Amazon then provides resources to its portfolio businesses in the form of investments (such as buying Whole Foods), and Amazon’s conglomerate balance statement yields Capital, as Amazon’s equity-share price in the stock market.
The strategic business model, for each business in Amazon, transforms value as retail enterprises. Each of Amazon’s portfolio companies (such as Whole Foods) takes resources as an input (such as packaged food into Whole Foods’ grocery stores) and then sells these package foods to customers as sales. The invested capital from the conglomerate Amazon is a capital input into each portfolio business, and profit from sales by each business are outputs of each retail enterprise.
Thus two types of business models are needed to depict Whole Foods’ operational strategy and Amazon’s operational strategy. The need for two models can be seen in the example of Amazon’s strategy of acquiring new businesses. Nick Wingfield wrote:
The company (Amazon) is exploring the idea of creating stores to sell furniture and home appliances, like refrigerators – the kinds of products that shoppers are reluctant to buy over the internet sight unseen …. Amazon is also kicking around an electronics-store concept similar to Apple’s retail emporiums …. These shops would have a heavy emphasi...
