1 Confidential - for classroom use only Business Model Analysis

1Confidential - for classroom use only

Business Model Analysis

What Is a Business?

Per Theodore Levitt,

1. The purpose of a business is to create and keep a

customer.

2. To do that you have to deliver goods and services that

people want

3. To continue to do that, the enterprise must be profitable

4. Businesses must clarify their purposes, strategies, and

plans.

5. And in all cases, there must be an appropriate system of

rewards, audits, and controls to ensure that what is

supposed to happen actually happens

What is a Model?

Per Paul Krugman:

A model is any simplified representation of reality that is used

to better understand real life situations. But how do we create a

simplified representation of an economic situation?

One possibility – an economist's equivalent of a wind tunnel – is to

find or create a real but simplified economy.

The importance of models is that they allow economists to focus

on the effects of only one change at a time. That is, they allow us

to hold everything else constant and study how one change affects

the overall economic outcome.

What is a Business Model?

1. The way a business creates and keeps customers

2. The way a business

─ Organizes inputs

─ Converts inputs into value-creating outputs

─ Delivers the outputs to customers

─ Gets customers to pay for the outputs

─ Earns a profit

3. The way a business establishes competitive

advantage

Per John Mullins

It is about taking your good idea and developing it into a business or other organization that has high

impact, solves the needs of or even delights your customers, makes you and your investors money, and

is sustainable in the long term.

But what do we really mean by business model? It’s a phrase that, since its advent during the dot-com boom and

bust, has come to mean everything and anything and nothing at all.

By business model, we mean the pattern of economic activity—cash flowing into and out of your business for

various purposes and the timing thereof—that dictates whether or not you run out of cash and whether or not

you deliver attractive returns to your investors.

In short, your business model is the economic underpinning of your business, in all of its facets.

Every business model, whether viable or not, comprises five key elements. These elements, taken together,

determine the economic viability of any business that you might pursue. They determine whether

you’re likely to run out of cash, or not. They are the content of your business model, the building blocks

that underlie the financial statements that will eventually measure your company’s results. Each of the five

elements in our business model framework answers one or more key questions, each focused on cash—cash

coming in, or cash going out: John Mullins and Randy Komisar, Getting to Plan B (Harvard Business Review Press: 2009)

The Five Key Elements of a Business Model

1. Your revenue model: Who will buy? How often? How soon? At what cost? How much

money will you receive each time a customer buys? And how often will they send you

another check? This set of questions will not result in one, tidy number. It will produce

many elements that should be supported by an analog or, if not, become a leap of faith and

properly considered.

2. Your gross margin model: How much of your revenue will be left after you had paid the

direct costs of what you have sold?

3. Your operating model: Other than the cost of the goods or services you have sold, what

else must you spend money on to support the sale?

4. Your working capital model: How early can you encourage your customers to pay? Do

you have to tie up money in lots of inventory waiting for customers to buy? Can you pay

your suppliers later, after the customer has paid?

5. Your investment model: How much cash must you spend up front before enough

customers give you enough business to cover your operating costs? John Mullins and Randy Komisar, Getting to Plan B (Harvard Business Review Press: 2009)

Per Clayton Christensen

So what is a business model? It is an interdependent system composed of four components :

1. The starting point in the creation of any successful business model is its value proposition—a product or service that

can then targeted customers do more effectively, conveniently, and affordably a job that they’ve been trying to do.

2. Managers then typically need to put in place a set of resources—including people, products, intellectual property,

supplies, equipment, facilities, cash, and so on— required to deliver that value proposition to the targeted customers.

3. In repeatedly working toward that goal, processes coalesce. Processes are habitual ways of working together that

emerge as employees address recurrent tasks repeatedly and successfully. These processes define how resources are

combined to deliver the value proposition.

4. A profit formula then materializes. This defines the required price, markups, gross and net profit margins, asset turns,

and volumes necessary to cover profitably the costs of the resources and processes that are required to deliver the value

proposition.

Profit Formula: Assets and fixed cost structure, and the

margins and velocity required to cover them

Processes: Ways of working together to address

recurrent tasks in a consistent way: training, development, manufacturing, budgeting,

planning, etc.

The Value Proposition: A product or service that helps customers do

more effectively, conveniently, and affordably a job they’ve been trying to do

Resources: People, technology, products, facilities,

equipment, brands, and cash that are required deliver this value proposition to the targeted

customers

Clayton M. Christensen, et. al. The Innovator’s Prescription (McGraw-Hill: 2009).

Business and Competitive Analysis

by Craig Fleisher and Babette Bensoussan(FT Press: 2007)

Confidential – For Classroom Use Only

The Business ModelA business model has been defined as the “core logic by which a firm creates

customer value.” Organizations that take leadership positions in their

industries succeed by having an outstanding business model and executing it

masterfully.

Business model analysis (BMA) provides the tools to quantify the relative

strength of an organization’s business mode to generate economic rents

from a product or service.

It acts as the link between the social domain, where economic rents are

generated, and the creative domain, where products and services are

conceptualized. With a detailed examination of the components of the business

model, the analyst can determine what in particular makes one business

model superior to another, thus creating an effective understanding of the

linkage between rents and the raw product or service.

However, a business model cannot exist in isolation and must be viewed

thorough the lens of competition; it is in this analysis that the superiority of

one model over another may be established.

Elements of the Business Model

The elements of the business model for companies to consider are the following:

1. The value proposition in the positions it adopts.

2. The market segments it chooses to serve or avoid.

3. Its value chain and the resulting costs from the activities it performs or

the resources it employs.

4. Its revenue model (or models) and the resulting profit potential.

5. Its position and strength in the larger upstream and downstream value

network, including competitors and complementors.

6. Its competitive strategy and how it seeks to gain a sustainable

competitive advantage.

Understanding the elements of a model at a detailed level allows a firm to change

it to potentially generate larger economic rents, disrupt competitors, or to use it to

competitive advantage.

Step 1: Articulate the Value Proposition

Value is determined by the customer—the firm needs to define the

product or service it will provide and the forms in which a

customer may use it.

The value proposition will change depending on the target market

specified, and there may be an iterative process between Steps

1 and 2, with a different proposition specified for each target

segment.

The firm, through its value proposition, may choose to position its

products or services as low cost, differentiated, or niche-focused.

Step 2: Specify the Target Segment

Unless the firm is a very specific niche player, it may serve multiple segments of

the market, and it may need to specify the changing propositions for each

segment it chooses to serve and from whom it will derive economic rents. Quite

often, a business provides more than one service or product.

Segments can be broken down broadly by

1. customer characteristics unrelated to the product, generally known as

demographics (i.e., geographic span, socioeconomics, etc.);

2. product and/or service-related approaches that define user types, usage,

and benefits generally known as psychographics.

The analyst should pursue a detailed analysis of each market segments served by

the firm and tie the value proposition to customers who may desire different

aspects of the product or service.

The objective is that customers’ needs must be understood, along with their growth

potential.

Step 3: Determine Competitors

A firm exists within its industry because it serves those customers who see its

value proposition as superior to its competitors. Typically, firms serving the same

customer segments with the same product or service are perceived as “the

competition.” These firms will occupy a similar position along the industry value

chain and may have similar resource characteristics.

However, there may be firms that provide substitute products; companies that

operate in niche markets; and suppliers or customers that have a credible threat

of for or backward integration.

Firms that cause companies to forfeit their leadership positions are rarely obvious

and do not attempt to compete directly against established rivals; instead, they

find new ways to deliver value to customers.

Firms often surrender segments hat have become unprofitable due to

commoditization and later discover that those same competitors have moved up

the experience and learning curves and now threaten another segment.

Step 4: Evaluate the Value Chain and the Cost Model

A value chain identifies a series of activities that must be

undertaken to transform inputs into a product or service

delivered to customers.

With the ultimate goal of delivering value to, and capturing

economic value from, the customer, it is imperative that the

value chain be understood.

To deliver the right value to the appropriate market segments,

price it correctly, and position itself properly, a firm must

undertake a specific set of activities.

Using value chain analysis, these activities can be analyzed to

identify which step or steps provide economic advantage.14

Step 5: Evaluate the Value Network

It is important to consider the value the firm is capable of

capturing in its extended value chain or its relative position

to its customers, suppliers, and rivals.

The relative positioning of a product or service is critical. If a

firm produces a product or service that it can supply to only

one customer, it will be in an inferior position as its

customer will have significant bargaining power.

This value network analysis should include suppliers,

customers, complementors, and competitors.

Step 6: Determine the Revenue Model for the Firm The revenue model should describe each revenue stream and how each stream

brings in revenue; for example, a newspaper may have streams from direct

newsstand sales, paper box sales, subscription, advertising, classifieds, and

the Internet, and each of these revenue streams will incur a different cost.

The evaluation of the revenue model should include an understanding of price

compared to the competition, the value proposition, product quality, service,

and the value customers perceive in the model.

The analyst should also be able to determine if the revenue/cost model at this

stage is superior to that of the competition and is likely to produce better

profits.

The key here is also profit potential, and this may be determined from actual

financial results, although they can be misleading if viewed from a point in time

—a firm may not have matured and lay be in its startup stage; the more

important measure then becomes profit potential.

Step 7: Determine the Critical Success Factors for the Industry

Critical success factors (CSFs) are a limited set of aspects that are necessary to secure

and gain a competitive advantage. CSFs represent those areas that are critical to a firm’s

success, providing a direct link to organizational performance. John F. Rockart defined

four basic sources of CSFs, as follows:

1. Specific industry characteristics —The airline industry, for example, must provide

frequent, on-time flights to successfully target business customers.

2. Those arising from the chosen strategy of the business —High level of

technical service is an important factor for companies seeking to differentiate

themselves in :he welding industry.

3. Environmental characteristics or those resulting from economic or

technological change —For example, a telecommunications firm taking advantage

of deregulation in the industry.

4. Those arising from the internal needs of the firm —An organic structure may be

critical to a firm that has to compete in a highly innovative environment.

Critical success factors that relate to position, activities, resources, and costs will be used

to determine the strength of the business model. 17

Step 8: Complete an Analysis Grid Detailing Each Element of

the Business Model

The objective of this analysis is to detail where in its

business model a firm is capable of producing a superior

result.

To complete the analysis, each element of the business

model is placed in a grid.

Each element is ranked from 1 to 5 (superior) for the target

firm and its competitors on an analysis grid.

Appendix:Business Model Analysis for

Medical Devices

Stanford Model for Medical DevicesAn important step in the development of any new medical innovation is determining

the type of business model that will best support its commercialization.

Traditionally, business models have been used to outline how a young enterprise

will make money. However, current thinking has broadened the scope and focus of

business models to include how a company will deliver value to its customers.

An effective business model also addresses how a company should organize

its resources and processes to support its profit model, and how interactions

with customers and other external stakeholders should be managed to

achieve mutually beneficial results.

The defining characteristics of any business model are:

1. The innovation (product, service, or blend).

2. The customer(s).

3. The interface between the two (or the way they interact). Stanford Casebook

Delivering Value through the Business ModelAn appropriate business model allows the company to extract value for its innovation in a way that

makes sense to the customer.

The primary considerations impacted by the interactions between the customer and the innovation include:

1. Revenue stream – How revenue is generated and its frequency.

2. Sales/distribution channel – The required mechanism for getting the innovation into customers’

hands.

3. Price – How much the business can charge for its products or services.

4. Margin structure – The profit to the company from sales (and its adequacy to support the inherent

characteristics of the chosen business model).

5. Competitive differentiation – The degree to which the innovation is unique.

6. Intellectual property (IP) – The importance of IP protection to the success of the business model.

7. Other barriers to entry – Factors that could serve as barriers to adoption (e.g., high switching

cost, bran or customer loyalty, access to distribution channels, etc.).

8. Training requirements – The extent to which specialized training is required to utilize the

innovation.

9. Clinical hurdles – The complexity and duration of the clinical requirements that need to addressed

in order to commercialize the innovation.

10. Financial requirements – The level of investment necessary to develop and commercialize the

innovation.

11. Risk/liability – The level of risk to all stakeholders from either adopting of failing to adopt the

innovationStanford Casebook

1. Disposable ProductsDisposable Products are those goods that are used and then discarded without being

reused. Low cost disposables include items such as paper examination gowns and stopcocks

(used with intravenous tubing), both of which might costs pennies per unit. Whether they are

attached to medical equipment or reusables, low cost disposables:

– Require high sales volumes (to compensate for low margins).

– Must be easy to use.

– Should be marketable through low cost distribution channels (e.g., medical

equipment catalogs).

Higher cost disposables typically require specialized training to use and, as a result, require

significantly higher margins in order to support a technical sales force and ensure the

maintenance of a reasonable level of IP coverage. Competitive differentiation, in terms of

enabling superior clinical results or establishing key barriers to entry to the competition, are

also important for higher cost disposables.

In terms of their advantages, disposable products generate a regular revenue stream since

companies must acquire them on an ongoing basis. In addition, as the volume of

procedures increases (a goal of most healthcare providers), so too does the volume of the

disposables used. Stanford Casebook

2. Reusable Products

Reusable Products are multi-use products with a moderate lifespan. Scalpel

holders and Bunsen burners s examples of products that can be reused for a

period of time before they eventually wear out and need to be replaced.

Reusables can be attached to a disposable (e.g., the surgical shaver that is used

with the disposable razor blades mentioned earlier) or a service (e.g., servicing

of flexible endoscopes).

Business models built solely around a reusable product tend to have no sources of

recurring revenue other than replacement. As a result, they generally cannot

support a specialized sales force and are commonly sold through medical

catalogs and/or through major distribution companies. Reusable products also

carry with them a higher level of risk since customers use ‘ them for an extended

period.

However, because the products have a finite lifespan (which is much shorter than

the lifespan for capital equipment—see below), customers are/ typically unwilling

to pay a great deal for maintenance. This contributes to the factors that make

reusables a difficult business model to profitably sustain and grow. Stanford Casebook23

3. Implantable ProductsImplantable Products are typically mid ($l,000-$5,000) to high (> $5,000) cost items. An

sample of a mid-cost implantable device is a coronary artery stent. Examples of high

cost implantable devices are pacemakers and artificial joints. Implantable products can

be pure, or can be associated with a service, such as pacemaker follow-up service.

Implantable products require the highest level of clinical validation and, as a result, can

present significant clinical hurdles to their developers.

One benefit of a business model focused on implantable devices is that the device have a

direct pairing of the value proposition and the procedure—every patient that receives

the procedure gets one or more implants. As a result, implantables have an ongoing

revenue stream whose growth is linked directly to the increase in the number of

procedures performed each year.

From a risk perspective, however, implantables represent a recurring liability to the

company that manufacturers and markets them. Many devices have a limited life, even

as an implantable. The challenge to the company is to design an implant that can be

replaced or otherwise taken out of service before it malfunctions. In addition,

implantable products often require a direct sales force at the point of care to stay in

touch, answer questions, and provide follow-up—& requirement that can be costly for a

company to maintain. Stanford Casebook

4. Capital Equipment Products

Capital Equipment Products are, in essence, another form of reusable product.

They require customers to make a capital expenditure in order to obtain a

technology that they will use repeatedly. Capital expenditures come from funds

used by companies or entities, such as hospitals, to acquire or upgrade physical

assets to maintain or increase the scope or competitiveness of their operation.

These products can also be associated with a service | (e.g., technical support and

maintenance contracts) or with disposables. In these scenarios, it is lot

uncommon for the equipment to be sold at or near cost, with the expectation that

greater. Recurring revenue will come from the sale of the service and/or

disposables.

Capital equipment purchasing decisions usually occur at the administrative level in

the healthcare system. As a result, the sales cycle can be long (as much as 18

months) and may require the vendor to support the sale with a careful business

case for the purchasing decision (a plan for how will the purchaser will recoup

the investment in the capital equipment). Stanford Casebook

5. ServiceService is work performed by one person or group for the benefit of another. A

long-term care facility is an example of a pure service model. As noted, services

can also be attached to products. For instance, a service plan to maintain and

support an MRI machine after they have en implanted represents a blended

product/service model.

Pure service models can be challenging. They are highly dependent on having the

right management capabilities, organization tools, and resources on staff to

make the model a success. Furthermore, customers tend to be sensitive to

changes in management and company leadership, often valuing their personal

relationships with individuals within the company higher than the service the

company provides. Additionally, there are few economies of scale that e realized

in a service business.

Stanford Casebook26

6. Fee per UseFee per Use can be appropriate for innovations that sit squarely at the (intersection of

products and services. For example, laser eye surgery requires a capital

expenditure to cover the cost of the equipment. However, practitioners are also

charged a fee very time they perform a surgery using the machine. The event that

triggers a payment to the company is nothing other than use of the machine.

Another form of the fee per use business model in the medical device field is referred

to as a capitated model. In a capitated model, a medical provider is given a set fee

per patient, regardless of treatment or equipment required. Example, a company

that offers all the disposables necessary to perform a laparoscopic gallbladder

removal may charge a fixed price per patient, regardless of which disposables are

actually used. Similarly, a company with cardiology products may charge a fixed

fee per patient for all the stents, balloons, and catheters required to perform certain

predefined procedures. This approach allows companies with broad product lines

to achieve an advantage over those that offer a smaller number of related bundling

of products makes it more difficult for less diverse competitors to penetrate

accounts. Stanford Casebook

7. Over the Counter ProductsOver-the-Counter Products (OTC) business model depends on patients’ ability to

choose a treatment path and then acquire the product(s) for themselves. OTC

products can be Motrin, Benadryl) or devices (e.g., steam machine for treating

sinus congestion). OTC products can, at times, be combined with services. For

example, companies filling at-home blood pressure monitoring devices may offer

data analysis and feedback services to users who upload their blood pressure

readings via a computer.

Because physicians often are not involved in recommending OTC treatments, they

must be relatively simple and easy to use. Advertising is usually targeted directly

to consumers, and generic retail outlets (e.g., Walgreen’s) can be used to

support sales. On the upside, OTC products rarely require an expensive direct

sales force.

Within this construct, companies at times find it challenging to differentiate their

products since consumers spend less time than physicians understanding the

clinical benefits of one product over another.

Stanford Casebook28

8. Prescription ProductsPrescription Products: Prescription drugs provide a classic example of

prescription-based medical products. However, prescriptions can also be used

for devices and combined with services (e.g., physical therapy), disposables

(e.g., blood glucose monitoring testing strips), and hardware (e.g., nerve

stimulator pain control units). With this type of business model, the physician

selects the treatment and directs the patient toward it, but the patient is still

required to act on the physician’s instructions.

Because the large pharmaceuticals companies have so much advanced expertise

in marketing, prescription markets can be difficult to penetrate for small start-ups.

Companies are often advised to enter the prescription business only if their

product is clearly differentiated from the competition and/or if they can enter into

a co-development partnership with a large pharmaceutical company that has an

established sale force. “Me too” products have little chance of success without

the marketing “muscle” and deep pockets of a major partner.

Stanford Casebook29

9. Physician-Sell ProductsPhysician-Sell Products are those treatments that are sold directly through

physicians. With this business model, the physician essentially becomes a retailer

for the product and usually receives some direct incentive for helping to promote

and provide the treatment. Common examples include BOTOX injections, teeth

whitening products, and hearing aids. Physicians can also sell disposables, such

as contact lenses or solutions.

Typically, physician-sell products are offered on an outpatient basis and are often

paid for by the patients (rather than by insurance). Once again, the margins for

products sold through this channel must be high enough to cover not only the

compensation to the company, but also to the physician for being a distributor.

While some physician-sell products can be quite profitable, the primary downside

to this model is the potential for ethical conflict. Any time a physician receives a

direct incentive to steer a patient toward a particular treatment, questions may

arise bout whether the physician is truly keeping the patient’s best interests in

mind. For this reason, physician-sell products tend to be limited to non-essential,

elective treatments that patients may desire but are not medically indicated. Stanford Casebook

Appendix:Disrupting Healthcare

Business Models

Clayton M. Christensen, et. al.The Innovator’s Prescription

(McGraw-Hill: 2009)

Disrupting Healthcare Business ModelsThe problems facing the health-care industry actually aren’t unique. The products and services offered in

nearly every industry, at their outset, are so complicated and expensive that only people with a lot of money

can afford them, and only people with a lot of expertise can provide or use them. – Only the wealthy had access to telephones, photography, air travel, and automobiles in the first decades of those industries.

– Only the rich could own diversified portfolios of stocks and bonds, and paid handsome fees to professionals who had the expertise to buy and

sell those securities.

– Quality higher education was limited to the wealthy who could pay for it and the elite professors who could provide it.

– And more recently, mainframe computers were so expensive and complicated that only the largest corporations and universities could own

them, and only highly trained experts could operate them.

It’s the same with health care. Today, it’s very expensive to receive care from highly trained professionals.

Without the largesse of well-heeled employers and governments that are willing to pay for much of it, most

health care would be inaccessible to most of us.

At some point, however, these industries were transformed, making their products and services so

much more affordable and accessible that a much larger population of people could purchase them,

and people with less training could competently provide them and use then. We have termed this

agent of transformation disruptive innovation. It consists of three elements:

1. Technological enabler. Typically, sophisticated technology whose purpose is to simplify, it routinizes

the solution to problems that previously required unstructured processes of intuitive experimentation to

resolve.

2. Business model innovation. Can profitably deliver these simplified solutions to customers in ways

that make them affordable and conveniently accessible.

3. Value network. A commercial infrastructure whose constituent companies have consistently disruptive,

mutually reinforcing economic models.32

Disruptive Technological Enablers in Healthcare

Our bodies have a limited vocabulary to draw upon when they need to express that something

is wrong. The vocabulary is comprised of physical symptoms, and there aren’t nearly

enough symptoms to go around for all of the diseases that exist—so diseases essentially

have to share symptoms. When a disease is only diagnosed by physical symptoms,

therefore, a rules-based therapy for that diagnosis is typically impossible—because the

symptom is typically just an umbrella manifestation of any one of a number of distinctly

different disorders.

The technological enablers of disruption in health care are those that provide the ability

to precisely diagnose by the use of a patient’s condition, rather than by physical

symptom. These technologies include molecular diagnostics, diagnostic imaging

technology, and ubiquitous telecommunication. When precise diagnosis isn’t possible, then

treatment must be provided through what we call intuitive medicine, where highly trained

and expensive professionals solve medical problems through intuitive experimentation and

pattern recognition. As these patterns become clearer, care evolves into the realm of

evidence-based medicine, or empirical medicine—where data are amassed to show that

certain ways of treating patients are, on average, better than others. Only when diseases

are diagnosed precisely, however, can therapy that is predictably effective for each patient

be developed and standardized. We term this domain precision medicine.33

Disruptive Technological Enablers in Healthcare (contd.)

Disruption-enabling diagnostic technologies long ago shifted the care of

most infectious diseases from intuitive medicine (when diseases were

given labels such as “consumption”) to the realm of precision medicine

(where they can be defined as precisely as different types of infection,

different categories of lung disease, and so on).

To the extent that we know what type of bacterium, virus, or parasite causes one of

these diseases—and when we know the mechanism by which the infection

propagates—predictably effective therapies can be developed—therapies that

address the cause, not just the symptom.

As a result, nurses can now provide care for many infectious diseases, and

patients with these diseases rarely require hospitalization. Diagnostics

technologies are enabling similar transformations, disease by disease, for

families of much more complicated conditions that historically have been lumped

into categories we have called cancer, hypertension, Type II diabetes, asthma,

and so on.

Disruptive Business Model InnovationsIn health care, however, many technological enablers have not yet been translated into lower-

cost, higher-quality, more accessible services. The reason? Because of the factors we will

explore in this book, the delivery of care has been frozen in two business models—the

general hospital, and the physician's practice—both of which were designed a century ago,

when almost all care was in the realm of intuitive medicine.

The lack of business model innovation in the health-care industry—in many cases because

regulators have not permitted it—is the reason health care is unaffordable.

Generically, there are three types of business models:

1. solution shops,

2. value-adding process(VAP) businesses, and

3. facilitated networks.

The two dominant provider institutions in health care—general hospitals and physicians’

practices—emerged originally as solution shops. But over time they have mixed in value-

adding process and facilitated network activities as well. This has resulted in complex,

confused institutions in which much of the cost is spent in overhead activities, rather than in

direct patient care. For each to function properly, these business models must be

separated in as “pure” a way as possible.

Confidential – For Classroom Use Only 36Clayton M. Christensen, et. al. The Innovator’s Prescription (McGraw-Hill: 2009).

1. Solution ShopsSolution Shops are businesses that are structured to diagnose and solve unstructured problems.

Consulting firms, advertising agencies, research and development organizations, and certain law firms

fall into this category. Solution shops deliver value primarily through the people they employ—

experts who draw upon their intuition and analytical and problem-solving skills to diagnose the

cause of complicated problems. After diagnosis, these experts recommend solutions. Because

diagnosing the cause of complex problems and devising workable solutions has such high subsequent

leverage, customers typically are willing to pay very high prices for the services of the professionals in

solution shops.

The diagnostic work performed in general hospitals and in some specialist physicians’ practices

are solution shops of sorts. Highly trained experts amass information from imaging and other

monitoring equipment, analysis of blood and tissue samples, and personal physical examinations.

They’ll then intuitively develop hypotheses of the causes of patients’ symptoms. When the diagnosis is

only an uncertain hypothesis, these experts typically test the hypothesis by applying the best available

therapy. If the patient responds, it verifies the hypothesis. If not, the experts iterate through cycles of

hypothesis testing in an attempt to diagnose and resolve the problem.

Payment almost always is made to solution shop businesses in the form of fee for service. We’ve

observed that consulting firms such as Bain and Company occasionally agree d be paid in part based

upon the results of the diagnosis and recommendations their teams have made. But that rarely sticks,

because the outcome depends on many factors beyond the correctness of the diagnosis and

recommendations, so guarantees about total costs ultimate outcomes can rarely be made.

2. Value-Adding Process BusinessesOrganizations with value-adding process business models take in incomplete or broken things and then

transform them into more complete outputs of higher value. Retailing, restaurants, automobile

manufacturing, petroleum refining, and the work of many educational institutions are examples of VAP

businesses. Some VAP organizations are highly efficient and consistent, while others are less so.

Many medical procedures that occur after a definitive diagnosis has been made are value-adding

process activities. These range from a nurse prescribing medication to cure strep throat after it was

diagnosed by a rules-based diagnostic test, to hernia repair, angioplasty, and laser eye surgery. VAP

procedures are possible only after a definitive diagnosis has been made first—quite often in a solution shop.

When VAP procedures such as these are organizationally separated from those of solution shops, overhead

costs drop dramatically: focused VAP clinics typically can deliver comparable care at prices that are half of

those incurred in hospitals and physicians’ practices in which VAP and solution shop business models are

conflated. Institutions such as the MinuteClinic, Shouldice Hospital, eye surgery centers, and certain focused

heart health and orthopedic hospitals are examples of value-adding process businesses.

Businesses typically charge their customers for the output of their processes, whereas solution shops

must bill for the cost of their inputs. Most of them even guarantee the result. They can do this because the

ability to deliver the outcome is embedded in repeatable and controllable processes and the equipment

used in those processes. Hence, restaurants can print prices on their menus, and universities can sell credit

hours at guaranteed prices. Manufacturers of most products publish their prices and guarantee the result for

the period of warranty.

Many who have written about the problems of health care decry the fact that the value of health-care services

being offered by hospitals and doctors is not being measured. To them, we would explain that the reason isn’t

that these providers don’t want to provide measurable value; they simply can’t because under the same roof

they have conflated fundamentally different business models whose metrics of output, value, and

payment are incompatible with one another. 38

3. Facilitated NetworksThese are enterprises in which people exchange things with another. Mutual insurance companies

are facilitators of networks: customers deposit their premiums into tie pool, and they take claims out of

it. Participants in telecommunications networks send and receive calls and data among themselves;

eBay and craigslist are network businesses. In this type of business, the companies that make money

tend to be those that facilitate the effective operation of the network. They typically make money

rough membership or user fees.

Networks can also be an effective business model for the care of many chronic illnesses that rely

heavily on modifications in patient behavior for successful treatment. Until recently, however,

there have been few facilitated network businesses to address this growing portion of the world’s

health-care burden.

Organizations like dLife, which facilitates the networking of people with diabetes and their families, are

evolving toward models that can deal with the particular challenges in treating these chronic illnesses.

Waterfront Media and WebMD are building facilitated networks for patients with chronic diseases.

Harnessing a vast array of patient data, they’re building the capability for patients to find

“someone like me.” This will allow patients to compare progress in treating their disease with

directly comparable patients, and ultimately enable those patients to communicate with and

learn from each other. The physicians’ practice business model is a horrible mismatch with the nature

of care for many chronic diseases. Facilitated network business models in health care can be

structured to make money by keeping people well; whereas solution shop and VAP business

models make money when people are sick.

Breaking Apart Incompatible Business ModelsSo what’s the answer? The health-care system has trapped many disruption-enabling

technologies in high-cost institutions that have conflated two and often three business

models under the same roof. The situation screams for business model innovation.

The first wave of innovation must separate different business models into separate

institutions whose resources, processes, and profit models are matched to the nature and

degree of precision by which the disease is understood. Solution shops need to become

focused so they can deliver and price the services of intuitive medicine accurately.

Focused value-adding process hospitals need to absorb those procedures that general

hospitals have historically performed after definitive diagnosis. And facilitated networks

need to be cultivated to manage the care of many behavior-dependent chronic diseases.

Solution shops and VAP hospitals can be created as hospitals-within-hospitals if done

correctly.

Hospitals and physicians’ practices have long defended themselves under the banner, “For

the good of the patient.” Yet, for the good of the patient, do we really need to leave all

care in the realm of intuitive medicine? Much technology has moved past this point,

and health-care business models need to catch up.

40Clayton M. Christensen, et. al. The Innovator’s Prescription (McGraw-Hill: 2009).

Summary: Disrupting Healthcare Business ModelsThe challenge that we face—making health care affordable and conveniently accessible to most people—

is not unique to health care. Almost every industry began with services and products that were so

complicated and expensive to provide and consume that only people with a lot of skill and a lot of

money could participate. The transformational force that has brought affordability land

accessibility to other industries is disruptive innovation.

Most disruptions have three enablers: 1. a simplifying technology,

2. a business model innovation, and

3. disruptive value network.

The technological enabler transforms a technological problem from something that requires deep

training, intuition, and iteration to resolve, into a problem that can be addressed in a predictable,

rules-based way. – Diagnostic abilities are the technological enablers of disruption in health care. Precise definition of the problem, in this and in every

industry, is a prerequisite to the development of a predictably effective solution.

In the past, business model innovation was common in health care. When the technological enablers

for the diagnosis and treatment of infectious diseases emerged, most patient care was transferred

away from hospitals to doctors’ offices, and away from the doctors to the nurses. However,

business model innovation has stalled in the last three decades. Regulations and reimbursement systems

currently trap in high-cost venues much care that could be provided in lower-cost, more convenient

business models. Other disruption fail because they lack new value networks that combine business

models into coherent ecosystems that allow them to disrupt their predecessors.

The Key LessonsThree key lessons from the history of disruptive innovation are particularly important in the disruption of health

1. The first is that while the technological enablers almost always emerge from the laboratories of

leading institutions in the industry, the business model innovations do not. Almost always these

are forged by new entrants to the industry. Regulators must beware, therefore, of attempts by the leading

institutions to outlaw business model innovation. Regulation should facilitate it. What is in the interest of

society most often does not coincide with the self-perceived interests of the leading institutions.

2. The second key lesson is that disruption rarely happens piecemeal, where stand-alone

disruptions are plugged into existing value network of an industry. Rather, entirely new value

networks arise, disrupting the old. Hence, disruptive business models such as value-adding process

clinics, retail clinics, and facilitated networks must be married with disruptive innovations in insurance and

reimbursement in order to reap the full impact in cost and accessibility. At the outset, knitting all these

pieces together will require a much higher degree of integration than has been the norm in the health-

care industry.

3. Finally, we have seen a pervasive pattern in every industry that has been transformed through

disruption. This same pattern characterizes what has happened to date with disruptive initiatives in

health care. The energies, talent, and resources of the leading organizations in organizations in an

established system always are absorbed in improving their best products, which are sold to

address the most demanding applications in the industry. Why? Because the high end of most

markets is where the most attractive profits are made, serving the most profitable customers. When a

disruptive technological enabler emerges, the leaders in the industry disparage and discourage it

because, with its orientation toward simplicity and accessibility, the disruption just isn’t capable of solving

the complicated problems that define the world in which the leading experts work. 42

Healthcare is No DifferentThe technological enablers of disruption are successfully deployed against the industry’s simplest problems

first. They then build commercial and technological momentum upon that foothold and improve, progressively

displacing the old, high-cost approach application by application, customer by customer, disease by disease.

Apple sold its Apple IIe personal computer as a toy to children, not to the accounting departments of major banks.

Nucor cut its teeth on concrete reinforcing bars, not the sheet steel that fed Ford. Cisco deployed its switches to route

data, not voice—because data didn’t care about the router’s four second latency delay, whereas voice

telecommunications did. Target started by selling things like paint, hardware, and simple kitchen supplies, not designer

clothing. JCB transformed the digging of big holes not by aspiring to use hydraulics technology to excavate massive

underground parking garages upon which skyscrapers would be built. JCB started by digging one-foot trenches to run

water lines from homes to the pipes under the street. Toyota’s launch vehicle was a Corona, not a Lexus.

Health care is no different. An illustration: angioplasty has transformed the interventional care of coronary artery disease

— making it much more affordable and much more convenient for many more people to receive effective treatment. It

was initially deployed against partially occluded, easy-to-access coronary arteries. Luckily, angioplasty wasn’t blocked

from the market just because it couldn’t beat the gold standard of open-heart bypass surgery, which was

unquestionably the best way to resolve intractable blockages in complicated locations. But step by step, stent by stent,

the minimally invasive approach has improved to the point where fewer and fewer people need bypass surgery. Now,

Pharmaceuticals, including lipid-lowering agents such as Lipitor, are disrupting angioplasty in the same manner. They

were not withheld from the market because they couldn’t dissolve defiant arterial blockages. But deployed as

prevention, patient by patient, these “statins” demonstrate reabsorption of atherosclerotic plaques that can obviate the

need for angioplasty.

The fact that cost-lowering, accessibility-enhancing disruptive enablers can address only the simplest of problems at the

outset is indeed a gospel of good news. It frees physicians and hospitals to focus their energies on what they do best—

tackling complex medical problems and moving more and more problems along the spectrum from intuitive toward

precision medicine .43

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