MANAGERIAL COGNITION, ACTION AND THE BUSINESS
MODEL OF THE FIRM
The final, definitive version of this article has been published in the Journal,
Management Decision, 43/6, 2005, Emerald Group Publishing Ltd. Publisher’s
version is available from http://dx.doi.org/10.1108/00251740510603565 .
Managerial Cognition, Action and the Business Model of
the Firm
Henrikki Tikkanen
Professor of Marketing
Helsinki School of Economics
Finland
[email protected]
Juha-Antti Lamberg
Research & Lecturer, Ph.D.
Institute of Strategy and International Business
Helsinki University of Technology
[email protected]
Petri Parvinen
Associate Dean, Ph.D.
Executive School of Business
Helsinki University of Technology
Juha-Pekka Kallunki
Professor of Financial Accounting
Department of Finance and Accounting
Faculty of Economics and Industrial Management
University of Oulu
Finland
Forthcoming in Management Decision 6/2005
1
Managerial Cognition, Action and the Business Model of
the Firm
The business model is a cognitive system through which managers decide on their actions.
Seeking to clarify the business model concept and promoting its use in management theory
and practice, this paper outlines a generic framework for the business model and proposes its
many linkages to cognition.
Keywords: business model, strategy, evolution, cognition, system, action
Management Decision 6/2005
2
Introduction
A growing number of management researchers, economists, and organizational theorists have
invoked the concept of a business model in their search for answers to a broadening range of
questions (e.g. Winter and Szulanski, 2001; Amit and Zott, 2001). For instance, Magretta
(2002) called for a consistent definition of the term business model, stating that it is used
erroneously and haphazardly among managers. Despite its vagueness, the business model
concept has become a pertinent notion in managerial vocabulary. Seeking to clarify the
concept and help to assess its utility for management theory and practice, this paper develops
a conceptual framework that identifies the key ‘components’ of a business model. The starting point for this paper is that a business model can be conceptualized as the sum of
material, objectively existing structures and processes as well as intangible, cognitive
meaning structures at the level of a business organization. The conceptual framework
presented in this paper naturally represents an archetype (Greenwood and Hinings, 1993).
Theoretically, the aim is to merge existing understanding on the material aspects of business
models with theories concerning cognitions and industry belief systems (Porac, Ventresca and
Mishina, 2002). From a managerial viewpoint, the primary contribution of this archetype is
the explicit definition of the scope of the intuitively clear but theoretically vague business
model concept.
We are interested in how the material aspects of firm-level business models interact with
managerial cognition and action. By the material aspects of a business model, we refer to the
tangible elements of a company’s strategy, business network, operations, and finance and accounting. By the cognitive aspects of a business model, we refer to the systemic meaning
structures or the belief system of a company. The belief system is seen as the driver of
decision-making and, subsequently, action. Business model evolution is also defined by the
relationships between managerial actions and their outcomes manifested in realized economic
exchanges and business results.
The paper is structured as follows. Firstly, we briefly review literature on firm-level business
models. Secondly, we discuss the role of cognition and action as determinants of a company’s 3
business model. Thirdly, we present our propositions that conceptualize the material aspects
of a business model. Finally, we present a model that identifies relationships between the
material aspects, cognitive mechanisms and action.
Business Model L iterature Review
The concept of a business model is nearly absent from academically oriented literature and
thus remains more or less under-conceptualized (Amit and Zott, 2001; Magretta, 2002).
However, the notion of a business model is frequently used applied in literature, especially in
the information and communication technologies (ICT) sector (Venkatraman, 2000; Hamel,
1999; von Krogh and Cusumano, 2001; Sweet, 2001; Mahadevan, 2000; Lechner and
Hummel, 2002). After the crash of the ICT sector in 2000, some authors have sought to
explain why the ‘new’ business models were not able to revolutionize the economy (Ratliff,
2002; Feng, Froud and Johal, 2001; Williams, 2001).
In recent academically oriented
management literature, the business model concept most often refers to value creation and
economic logic, especially in terms of revenue creation (Amit and Zott, 2002; Venkatraman
and Henderson, 1998).
The following definitions of the business model concept highlight the fragmented nature of
existing conceptualizations.

Business model is a coordinated plan to design strategy along the customer
interaction, asset configuration and knowledge leverage vectors (Venkatraman and
Henderson, 1998).

Business model depicts the content, structure and governance of transactions designed
to create value through the exploitations of business opportunities (Amit and Zott,
2002).

Business model is typically a complex set of interdependent routines that is
discovered, adjusted, and fine-tuned by “doing.” (Winter and Szulanski, 2001).
Amit and Zott’s (2002) business model concept is an exception in business model literature as it is explicitly theoretically anchored in value chain analysis, Schumpeterian innovation,
4
transaction cost economics, the resource-based view and strategic networks. The dimensions
of their concept include content novelty, complementarities among resources and capabilities,
and network effects. Other authors have also pointed out the importance of firm resources,
capabilities and learning to be systematically included in the firm’s business model (Eden and Ackermann, 2000). Moreover, the importance of including dynamism into the study of
business models has also been recently identified as a central issue. Winter and Szulanski
(2001) included dynamism in their analysis by identifying the need for the business model to
change at different phases of the replication strategy’s lifecycle and internationalization. Equally, Sauer and Willcocks (2003) emphasized that more important than knowing the
structure of a [business model] is the ability to create and effect new structures and processes
quickly and at low cost.
Despite these contributions, there is a lack of a unitary conceptualization of the business
model in academic literature. Thus, a need exists to build a framework that addresses all
relevant components of a firm’s business model as well as their interrelationships in the
functioning of the model. In addition to these more tangible aspects, the cognitive and
evolutionary aspects of a business model have been scarcely recognized in existing research.
Cognition and Action
The functioning of a business model becomes visible in managerial decisions and actions.
Actions and outcomes also emerge autonomously as a result of the systemic consequences of
different organizational configurations (Miller, 1986). The actualization of any outcomes (e.g.
in the nature of exchanges between economic parties or in the financial performance of the
firm) is thus dependent on the systemic properties of the firm’s business model. From a dynamic perspective, these outcomes also directly influence the evolution of the business
model.
Thus, the evolution of a business model is built on managerial actions that focus on certain
aspects of the business model. As Giddens (1984) and later institutional theorists (Barley and
Tolbert, 1997) have proposed, organizational actions are directly linked with the wider
institutional environment of the focal organization.
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The role of individual and organizational meanings and meaning structures is crucial in the
structuration process of a business model. In the presented business model framework,
organizational actors are seen as rule-followers who fulfill their identities by following
procedures they see as appropriate in the current context (March and Olsen, 1989). The
formal rules, beliefs and values define the appropriateness of different actions and thus make
firms’ evolution contingent not only on the business environment but equally on the firm’s history since rule systems typically evolve in time (March and Simon, 1963).
In practice, the cognitive aspects of the business model are firstly constituted by the meanings
and meaning structures which actors maintain about the components of the business model.
Secondly, the cognitive aspects also relate to the way in which actors perceive the functioning
of the business model. Briefly, we see cognitions as the conceptual and operational
representations that humans develop while interacting with complex systems. Thus, we refer
to cognition as both an individual and an organizational level process (Hill and Levenhagen,
1996; Walsh, 1995). It is important to note that we study managers’ cognitions of the business model of the firm they are developing, not the perception that others have of the firm or the
perception that managers have of other firms.
As stated in behavioural organization theory, cognitions act as a filter between the actors’ understanding of the inter-organizational environments and the intra-organizational context
(March and Simon, 1963). Hence, the belief system filters actors’ perceptions and beliefs concerning the function of the business model to certain organizational actions.
Our perspective to shared belief systems resembles Porac, Ventresca and Mishina’s (2002) four-level belief hierarchy that fuses several industry belief systems into a belief hierarchy in
which higher and lower –level beliefs are in constant interaction. Higher order beliefs thus
motivate change or stability in lower order beliefs. Following Porac et al. (2002), our
framework identifies four conceptual levels of managerial cognition related to the material
aspects of the business model of the firm: industry recipe, reputational rankings, boundary
beliefs, and product ontologies. Industry recipes are beliefs related to the logic of the
economic, competitive and institutional environment and their effects on the focal firm
(Spender, 1990). Boundary beliefs refer to social constructions that identify a focal firm with
a certain interorganizational community (Porac et al, 2002). Product ontologies are cognitive
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representations that link, for instance, product or service attributes, usage conditions, and
buyer characteristics into a definition of an offering that is hoped to become superior on the
target market (Porac et al, 2002). Finally, reputational ranking refers to how organizations
socially evaluate competition and their competitors vis-à-vis their own performance.
In sum, our conceptualisation of managerial cognition, action and the business model of the
firm builds on the following logic. Managers view and make decisions regarding the material
aspects based on their cognitions that can be located at the three conceptual levels of beliefs
identified above. Consequently, the mechanism underpinning the actualisation of any relevant
business related outcomes consists of how the material aspects of the business model interact
with managerial belief systems. This mechanism constitutes the business model of the firm.
The Material Aspects of a Firm’s Business Model We define the business model of a firm as a system manifested in the components and related
material and cognitive aspects. Key components of the business model include the company’s network of relationships, operations embodied in the company’s business processes and resource base, and the finance and accounting concepts of the company (Figure 1).
M aterial aspects of
the business model
Strategy and
structure
Operations
Belief system
Reputational rankings
Network
Actions
and
Industry recipe
Finance &
accounting
Business
model
evolution
Boundary beliefs
Product ontologies
outcomes
of
these
actions
F igure 1: T he business model of the firm
In the following, we propose some relationships between managerial cognition, action and the
components of the business model of the firm. Our propositions deal with reinforcement
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(‘cognition X reinforces action in component A), constraints (‘cognition Y constrains action in component B’) or correlation (‘the higher cognition Z, the higher action in component C’).
Strategy and Structure
Strategic Intent, Strategy Process and the Content of Strategy. The function of the
strategy is to give a meaning and direction for the development of the company’s business model. In other words, we see strategy as the comprehensive pattern of a company’s actions and intents binding together all the components of the business model (Mintzberg and Waters,
1982). Strategic intent, on the other hand, is the “driver” of the content and process of a company’s strategy (Hamel and Prahalad, 1990). Strategic intent involves long-term
organizational commitment to ambitious business objectives, creating a shared mindset and a
sense of direction for the company.
By the concept of the strategy process, we refer to the dichotomy of autonomous and induced
strategy processes (Burgelman, 2002). The induced strategy process refers to highly focused
strategy processes managed by rational actors represented by the top management of the
company. The autonomous process, then again, refers to the internal-ecological, emergent
processes that occur at all levels of the organization, especially among middle management.
The induced strategy process has a tendency to focus on some component or components of
the business model of a company whereas the pure autonomous mode automatically takes into
consideration most of the components. In most cases, however, both modes of strategy
process co-evolve reflecting, for instance, the culture, structure and operations in the
organization.
Approaches to the content of strategy have ranged from the classical planning perspective
(Ansoff, 1965; Andrews, 1980) to the widely referenced typology of Miles and Snow (1978),
to generic strategies of Porter (1980), and to more recent emergent and evolutionary
approaches to strategy (Mintzberg, 1987; Burgelman, 2002). These perspectives concentrate
on where strategy comes from e.g. the strive to differentiate, the environment, the daily
actions of the organization, the plan and the planner or the perceived typological role of the
company.
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As the business model approach presented in this paper does not concentrate on where
strategy content comes from, but rather discusses the components of the business model,
which embody ‘the strategy’, it rejects no origin. In essence, strategy does not concentrate on any particular aspect but on the totality constituted by the components of the business model
(cf. Hambrick and Fredrickson, 2001). The emphasis is thus on which ‘origins’ have an influence on which component or components of the business model and what this influence
is. In addition, we acknowledge that there is substantial interplay between the components of
the business model.
O rganizational Structure. From the perspective of a firm’s business model, the effects of strategies, processes and the environment on the organizational structures are vital in order to
find the link with organizational performance (Ketchen, McDaniel and Reuben, 1996). These
relationships are partially explained by configurations and emphasize the need to understand
the effects of organizational structure not only on strategy but on the strategic actions and
consequent economic development and business results as well (Ketchen et al. 1997).
We adopt the view that a leap from one structural archetype to another must proceed through
a number of phases and that organizations are thus capable of adapting to changing
environments (Miller and Friesen, 1982). This means that organizations are unable to
transform their structures without risk as each leap creates a disruption in organizational life
(Mintzberg and Waters, 1982). In this paper, we advocate a co-evolutionary perspective,
which emphasizes the relationship between structure and strategy. On the one hand,
organizational structure is a key determinant of decision-making. On the other hand, strategic
action is perceived to have power over organizational structures. Strategic choices and
resulting actions do change organizational structures, albeit mostly in an incremental fashion.
Evidence of this is that the current organizational reality can be thought to narrow down the
alternatives available for strategic action thus emphasizing strategizing as a function of the
present structure.
Governance. A further element in understanding corporate strategy deals with understanding
the existence, boundaries and internal organization of the firm. The idea of organizational
governance tackles these issues and has emerged as an important strategic perspective
(Williamson, 1999; Madhok, 2002; Foss, 1999). Governance is centrally comprised of
contracting-based literature that concentrate on the general treatment of contracting around
9
the issues of appropriation, ownership, alignment of incentives (Madhok 2002), self-interest
as well as authority, the employment relationship, economizing and coordination, financial
structure, regulation and property rights (Williamson 1999).
The managerial decision-making processes surrounding governance at level of the firm can be
conceptualized to operate in two realms. Firstly, governance modes can be managed by
initiating action along four continuums. These are the market-hierarchy continuum, the
economic logic continuum, the private-civic interest continuum and the legal incorporation
continuum. Typical actions include influencing the tightness of relationships (e.g. alliancebuilding), tightening or loosening the profit-making orientation (e.g. relinguishing profitmaximization targets), redefining the prioritization of stakeholder groups and changing the
legal incorporation of the organization (e.g. privatization).
Secondly, the governance practices of the company are susceptible to strategic decisionmaking. Governance practices encompass a wide but not indefinite set of contractual
arrangements within the firm that are more strategic than administrative in nature. Typical
governance practices include corporate governance practices, stakeholder management
strategies, outsourcing strategies, process ownership systems, reward, monitoring and penalty
systems, legal and contracting practices and even rules for process optimization within the
firm.
Regarding the relationships between the belief system of the firm and its strategy and
structure, we offer the following propositions:
Proposition 1: The less ambiguous the link between firm strategy and the totality of firm’s belief system, the more crystallized the strategic intent of a company and the more consistent
its actions.
Proposition 2: The more mature the industry and the more stable the related industry recipe
the more narrow the alternatives for structural change.
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Business Networ k
C ustomer Relationship Portfolio. The management of the customer relationship portfolio
(customer base) is identified as one of the most crucial aspects in the management of a
company’s business model. This task is executed through a customer relationship management (CRM; alternatively, key account management or KAM) process, addressing all
aspects of identifying customers, creating customer knowledge, building customer
relationships and shaping their perceptions of the organization and its offerings (Shrivastava,
Shervani and Fahey, 1999; Hunt and Morgan, 1995). The task of managing the customer
relationship portfolio is also seen as an evolutionary, interactive process occurring in the
business network of a firm (Anderson, Håkansson and Johanson, 1994).
In order to manage existing or potential customer relationships, their state, nature, outcomes
and developmental phases have to be understood. In terms of their state and nature, business
relationships can vary between competitive (market -based), cooperative (partnership -based)
and command (dominance –based or hierarchical) modes (Campbell, 1985). The outcomes of
business relationships have often been categorized into the more objective techno-economic
outcomes (e.g. customer relationship profitability, new technology development) on the one
hand and the more subjective psycho-social outcomes (e.g. trust, commitment and feelings of
success) on the other (Tikkanen and Alajoutsijärvi, 2001). Finally, the development phases of
business relationships typically include the pre-relationship, exploratory, developing, stable
(institutionalized), and dissolution stages (Ford, 1980).
More specifically, the CRM process consists at least the following sub-processes: identifying
of potential new customers, determining the needs of existing and potential customers
(customer value creation), developing the company’s product and/or service offering, developing and implementing marketing and sales programs, developing and managing the
channels of distribution, acquiring and leveraging information technology for customer
contact, management of customer-oriented production teams especially in industrial
companies, acquisition and dissemination of relevant market and customer information, and
cross-selling and up-selling of product and service offerings (cf. Shrivastava et al, 1999).
In our business model framework, the customer relationship portfolio of the company is the
major source of revenues and knowledge that facilitates an understanding of customer value
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creation and thus the development of offerings (Anderson and Narus, 1999). Customer value
creation is inherently connected to the core competencies of the company and its business
network (Anderson, Håkansson and Johanson, 1994). Moreover, customer value creation is
seen as the key determinant of segmentation (Anderson and Narus, 1999). In other words,
companies orient their core competencies and business processes towards optimal value
creation for their key customers or customer segments.
On a more general level, the CRM process is related to the functioning of a business model
essentially comprises of the management of the processes of a) exchanges and communication
between the economic parties, b) the coordination of production and exchange (transactions)
c) adaptations in both the offering and the coordinating structures and processes, and d)
customer and market intelligence (cf. Möller and Wilson, 1995).
The market/customer orientation of the organization doing marketing is also a basic emphasis
in CRM. In marketing literature, a market orientation typically characterizes a company’s disposition to deliver superior value to its customers. This requires an organization-wide
commitment to continuous information gathering and coordination of customer needs,
competitors’ capabilities, and the provisions of other significant market agents and authorities
(Slater and Narver, 1994). The result is an integrated organizational effort, which gives rise to
superior firm performance (Kohli and Jaworski, 1990).
Supplier Relationship Portfolio. The management of a company’s supplier relationship portfolio (supplier base) involves the continuous enhancement of the acquisition of inputs and
their transformation into desired customer outputs in the form of the aforementioned optimal
offering. This task is implemented through a supply chain management (SCM) process that
incorporates the acquisition of all tangible and intangible inputs as well as the efficiency and
effectiveness with which they are transformed into customer solutions (Shrivastava et al,
1999). Thus, the SCM process connects the suppliers’ business processes to the companyinternal processes such as materials management and manufacturing.
Supplier relationships can be scrutinized and managed on the basis of their state, nature,
outcomes and developmental phases much like the customer relationships discussed above. In
recent industrial supply chain management literature, however, a lot of emphasis is put on
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designing an appropriate supply architecture. This is usually achieved by focusing strongly on
a few key or 1st tier suppliers, operating a portfolio of 2nd tier suppliers etc.
Key sub-processes of supply chain management include at least the selection and qualification
of desired suppliers, logistics management, order processing, pricing, billing, rebates and
managing customer services to enable product use. From the viewpoint of our business model
framework, the supplier relationship portfolio management is essential for a) the
establishment of a secure basis for operational excellence and thereby lowering operational
risk and b) aligning the inputs for maximized value creation through procurement
(Shrivastava et al, 1999). The latter aspect deals with a much larger set of inputs than is
traditionally understood in industrial supply chain management as e.g. add-on and after sales
services present a major possibility for value leverage from the viewpoint of the business
model.
Product Development Networ k. The development of new customer solutions and/or the
reinvigoration of existing solutions is accomplished through a product development
management (PDM) process (Shrivastava et al, 1999). More generally, it has been noted that
companies’ research and development (R&D) processes are becoming increasingly networked (e.g. Powell, Koput and Smith-Doerr, 1996).
Key sub-processes of product development management include ascertaining customer needs
and value creation, offering development and testing, identifying and managing internal
relationships and developing and maintaining linkages with external co-operators. Moreover,
the management of the company’s product development project portfolio is of importance. The objective of the PDM activities is to develop offerings that ascertain optimal customer
value creation. On a more general level, the objective of R&D related to the development of a
business model is the productization and commercialization of innovations. In the case that
the development of a business model starts with an initial (technological) innovation, basic
research aiming at the creation of new innovations essentially falls out of the scope of R&D
activity as it is defined here. In terms of our business model framework, we thus prefer to talk
primarily about PDM. In our business model framework, PDM consists of two interrelated
key tasks: a) the management of the company’s entire product development project portfolio, and b) the management of the key intra- and inter-organizational relationships related to these
projects.
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E xtra-Business Relationships. In addition to the above-mentioned three key groups of
relationships, also other stakeholders can essentially influence the evolution of a business
model (Achrol and Kotler, 1999; Gummesson, 1999; Grönroos, 1994). Most importantly,
literature has identified at least relationships to competitors, relationships to debtors and
equity-holders, and mega relationships as crucial to any company’s operations. We have termed them extra-business relationships due to fact that these relationships usually do not
have a direct link to the company’s core business operations. Despite their importance in
corporate finance, we treat relationships to financiers also as extra-business relationships due
to the fact that they most often do not have a direct operational impact on the functioning of
the business model, with the exception of the price of debt finance negotiated directly with
debtors.
The function of extra-business relationships is to provide the business model of a firm with
e.g. institutional structures, reference points and resources and capabilities that are necessary
for the company’s operations. Extra-business relationships crucial for the operation of a
business model should be identified, scrutinized in terms of their state, nature, outcomes and
developmental phases, and managed in a systematic manner.
Regarding the relationships between the belief system of the firm and its business network,
we offer the following propositions:
Proposition 3: The higher the cognition of a firm’s own reputational ranking, the higher reputational rankings the firm seeks and expects from its customers and suppliers.
Proposition 4: The targets of a firm’s marketing efforts are constrained by the firm’s boundary beliefs about who it can pursue as a customer or serve as a supplier.
Proposition 5: The more focused the product ontology, the more structured, goal-oriented the
management of the product development project portfolio.
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O perations
Process A rchitecture. From the beginning of the 21st century, the importance of
organizational processes - activity chains within organizations - has been recognized.
Mechanistic Taylorian management science is one example of an attempt to make business
organizations’ work processes more effective. The world-wide success of Japanese companies
led to the emergence of Japanese principles in Western management literature during the
1980s. One could argue that this development, together with Porterian value chain analyses,
gradually brought horizontal business processes back to the focus of management attention.
For example, total quality management (TQM) was a horizontal process cutting across the
boundaries separating organizational units in order to leverage quality in companies’ products and activities (Ghoshal and Bartlett, 1995). More recent notions such as lean management
(Womack, Jones and Roos, 1990) and time-based competition and management (Stalk and
Hout, 1990) also contain the same basic ideas. Finally, business process reengineering (BPR)
aimed at showing companies how to organize functionally separated tasks into unified
horizontal business processes creating value for customers (Hammer, 1990).
The basic idea behind conceptualizing and categorizing business processes in organizations is
to identify and design repeatable business processes that have enough elements of consistency
(e.g. clearly identified inputs and outputs) to justify developing a common, ‘averaged’ process for an organization (Stoddard, Jarvenpaa and Littlejohn, 1996). Davenport (1994, 134) has
defined the concept of an organizational process as “…a structured set of activities designed
to produce a specified output for a particular customer or market. It has a beginning, an end,
and clearly identified inputs and outputs. A process is therefore a structure for action, for how
work is done.” Archer and Bowker (1995, 32) introduce a broader, less mechanistic approach:
“...the concept of business process... is the paradigmatic change in the way in which organizations are designed and subsequently managed. It represents a decisive movement
away from the traditional functional concept, with its high emphasis on vertical differentiation
and hierarchical control to a view which stresses horizontal integration across intra- and
interorganizational functions.” Process thinking thus permeates organizational and functional boundaries. Factual,
conspicuous organizational processes include e.g. order fulfillment, product development,
marketing and selling, customer service, network creation and operations, procurement,
15
facilities, systems, finance, human resources, regulation, and governance (Stoddard,
Jarvenpaa and Littlejohn, 1996, 59). Processes are the means through which companies are
able to realize their core competencies, i.e. what they really can perform for the customers.
Process architecture refers to a designed portfolio of dynamic processes. It is a horizontally
integrated collection of different kinds of processes in which the company’s core competencies crystallize.
Resource, C apability and Competence Base. In strategy and organization research,
competence-based approaches emerged after the 1970s. Most importantly, they consist of the
resource-based perspective of the firm (e.g. the resource dependence view by Pfeffer and
Salancik, 1978; the resource based view of e.g. Wernerfelt, 1984; and Dierickx and Cool,
1989), the dynamic capabilities perspective (Nelson, 1991; Teece, Pisano and Shuen, 1997),
the knowledge-based theory of the firm (Kogut and Zander, 1992; Nonaka and Takeuchi,
1995) and the core competencies/competence-based competition theory approach (Hamel and
Prahalad, 1990; Sanchez and Heene, 1997).
Resources can be defined as “anything which could be thought of as a strength or weakness of a given firm ... as those (tangible and intangible) assets which are tied semipermanently to the
firm ... brand names, in-house knowledge of technology, employment of skilled personnel,
trade contacts ..” (Wernerfelt, 1984). Organizational resources that are valuable, rare, difficult to imitate and non-substitutable can yield sustained competitive advantage (Barney, 1991).
Distinctive capabilities are “a set of differentiable skills, complementary assets and routines that provide the basis for a firm’s competitive capacities and sustainable advantages.” (Teece, Pisano and Shuen, 1997)
From the perspective of a firm’s operations, the resource and competence base is vital due to their influence on firm routines and resource acquisition. A routine is thought of as “the skill of an organization”. Capabilities (competencies, dynamic capabilities, higher-order organizing
principles…) are meta-routines that represent a firm’s capacity to sustain a coordinated deployment of routines in its business operations (Foss and Foss, 2000). The process
architecture, then again, is highly dependent on the acquisition of resources and capabilities in
strategic factor markets.
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According to this perspective, a firm’s managerial operations concentrate firstly on the identification of strategic factor market imperfections and acquiring them to the firm’s resource and competence base. Strategic factor market decisions are typically dichotomous.
Managerial decision-making orbits around whether or not to acquire some strategic factor of
production through e.g. recruitment, licensing or corporate acquisition. Secondly, the firm’s routines need to be designed to utilize the resource and competence base in a way that creates
sustainable competitive advantage. Thus another key aspect of the management of the
resource and competence base deals with the factual deployment of the available resources.
The management of a firm’s resource, capability and competence base concentrates on process of identifying factor market imperfections, acquiring relevant resources, designing
routines that utilize the resource base and the factual implementation of these routines.
Routines embody both the influence of strategic resource management as well as the everyday
operational activities of the firm.
Product and Service O fferings. The offering of a firm consists of chosen set products and/or
services designed to optimize and maximize the creation of customer value (Anderson and
Narus, 1999). The content of the offering varies across customer segments and the way in
which the offering creates value for the customers, and is based on the opportunities provided
by the current state of the resource base and process architecture.
The evolution of product and especially service offerings has an intimate linkage to the
management of resources and process architecture (Grönroos, 1990). The exchange,
coordination and adaptation processes related to matching offerings with customer needs are
thus facilitated by changes in the operations of the firm.
As the offering is constrained and facilitated by the organization of operations, significant
transitions in the structure of the offering, e.g. shifting from project to product offering or
from product to service offering, require major changes in the resource base and process
architecture.
The speed at which contemporary customer needs change has been proposed to exceed firms’ ability to adapt their entire resource base and process architecture to these changes.
Consequently, offerings as well as resource bases and process architectures have often taken a
17
modular form (Sanchez, 1999). The operations of the firm are governed by the design of the
firm’s offerings on the basis of customer value creation. Regarding the relationships between the belief system of the firm and its operations, we offer
the following propositions:
Proposition 6: The stronger the industry recipe, the more uniform process architectures will
be across competing firms.
Proposition 7: The narrower the firm’s beliefs in its operational boundaries, the fewer are its unique resources and competencies.
Proposition 8: Managerial cognitions of current and future product ontologies is a major
constraint and reinforcer in the evolution of product/service offerings.
F inance and A ccounting
C apital budgeting. In the contemporary financial environment, companies can acquire the
capital needed when making investments in real assets (capital budgeting decisions) from
many different sources (e.g. Berger and Udell, 1998). In addition, capital can be acquired in
many forms including debt, equity and mezzanine securities. Debt investors only accept very
low or moderate risk in their investments meaning that they require collaterals from the
company. On the other hand, equity investors can invest in high-risk companies, but they
require that the expected profitability of the company is high as a compensation for the high
risk. This is due to the fact the equity investors yield return on their investments only if the
value of the company increases.
Equity capital has become an increasingly important source of capital for many companies.
This is to large extent due to the fact that the importance of intangible assets in companies’ business models has increased. Equity investors can take the risk related to financing such
assets (e.g. Nakamura, 2003). This has forced companies to reconsider the requirements of
equity capital investors in various decision-making contexts including the profitability of the
18
capital budgeting projects, the profitability of customer segments or even individual
customers, or product development and pricing decisions. Projects that increase the value of
the firm should be preferred in capital budgeting decisions.
Capital budgeting methods should meet the requirements set by the financial environment.
The appropriate measurement of the cost of capital, and especially that of equity capital,
should be recognized in capital budgeting techniques that are based on net present values.
Equity investors’ requirement for the increase in the firm value will not realize if the company underestimates its true cost of equity capital. As a consequence, the company may lose its
possibilities to acquire equity capital. Therefore, the cost of capital should be measured in
accordance with such theories as Capital Asset Pricing Model (CAPM) by Sharpe (1963), and
the weighted average cost of capital (WACC) by Modigliani and Miller (1963). The use of
these methods ensures that the company will make capital budgeting decisions that are
acceptable from the investors’ point of view. This, in turn, ensures that the company will get the funds needed in the capital budgeting.
F inancial reporting. Financial accounting produces information needed by various
stakeholder groups of the company. Management accounting is needed to provide information
to managers inside the company. As a result of the increased importance of equity capital as a
source of funds for companies and the increased importance of intangible assets, financial and
management accounting systems are getting closer to each other. Equity investors require that
companies should disclose extensive information regarding their economic conditions. To
illustrate, international IAS (IFRS) accounting standards require, among others, the company
to disclose detailed information on its profitability and invested capital across various
business segments. A frequently applied performance evaluation method, EVA (Stern,
Stewart and Chew, 1995), is also based on the idea of taking into account the investors’ point of view.
Management accounting information systems produce the information of the current and
expected profitability of the firm and the capital intensity of alternative investment projects.
Activity-based cost accounting and balanced scorecard by Kaplan and Norton (1992) are
examples of current management accounting models needed to fulfill the information needs
required by investors.
19
Regarding the relationships between the belief system of the firm and its finance and
accounting system, we offer the following propositions:
Proposition 9: The stronger the cognition of reputational rankings, the more uniform the
capital budgeting and financial reporting practices of competing firms.
Proposition 10: The firm’s cognition of its boundaries constrains its use of management accounting practices and financial instruments.
Discussion
Intuitively, managers and researchers tend to believe that a firm’s business model is controllable through specific managerial interventions. For example, the entire corporate
turnaround literature is devoted to offer practical tools on how such pervasive changes can be
managed over short periods of time. Although we accept that managerial actions shape
business models in time, we do not continue the mechanistic logic in turnaround, process reengineering and strategic planning literature.
From an evolutionary perspective, the essential question is to understand why and how new
business models emerge and mutate from the existing stock of business model components
(e.g. Durandt, 2001). Romanelli (1991) recognized three clusters of research addressing the
evolution of organizations in general. The ‘organizational genetics’ view sees the evolution of organizational forms as a product of random variation. The ‘environmental conditioning’ perspective emphasizes entrepreneurial action, environmental imprinting or organizational
speciation as key evolutionary mechanisms. Finally, the ‘emergent social system’ view sees evolution as arising dynamically ‘…through the cumulative interactions of entrepreneurs and organizations toward the establishment of a new industry system (Romanelli, 1991).’ In the
present essay, we come closest to the third cluster as we define an evolutionary mechanism as
a process of imitation and mutation. In this process, existing firms produce new business
models in interaction with their social context including the society, competitors and
customers.
20
Following the co-evolutionary logic, we also see that some components of a firm’s business model change as a consequence of changes in the resource base. This ‘organizational speciation’ view can be complemented with a dialectic logic that explains changes in
resources and information as a product of interaction between multiple levels of analysis. As
an example of such an approach, North (1990) demonstrated how firms both follow existing
norms and belief systems as well as alter them thus occasionally contributing to the
emergence of new business models. We propose that new business models mutate from the
existing stock of business model components as a consequence of long-term co-evolutionary
relationship between the business model of the firm and the context in which it operates. In
the case of newly founded firms, the challenges of developing a business model are even
greater since each component needs to be built from scratch.
Conceptualizing business model evolution is an especially daunting challenge as the cognitive
belief system hierarchy essentially determines firms’ actions and business performance. As we have proposed, each material component is linked to the different layers of the belief
hierarchy. The higher order beliefs are more inert and change slower than the lower order
beliefs. The challenge derives from the fact that inert beliefs such as reputational rankings
instigate intentional interventions and change slowly as the evolutionary process develops in
time. From the business model perspective, this means that managers must evaluate their
interventions to specific material components in the light of the possible alternative
consequences to the belief system as well as to the other material components. Thus, the
entire business model is a complex web of both material and cognitive components that
changes through incremental mutations – whether intentional or purely evolutionary.
Table 1 presents our propositions about the relationships between the four-level belief system
and the material components of the business model of the firm.
21
Reputational rankings
Strategy and Structure
Network
Boundary beliefs
P roduct ontologies
The longer the industry
life -cycle and the more
stable the related industry
recipe the more narrow
the alternatives for
structural change
The less ambiguous the
link between fir m strategy
and the totality of fir m ’s
belief system, the more
crystallized the strategic
intent of a company and
the more consistent its
actions
The higher the cognition
of a firm’s own reputational ranking, the
higher reputational
rankings the fir m seeks
and expects from its
customers and suppliers
The targets of a firm’s marketing efforts are
constrained by the firm’s boundary beliefs about
who it can pursue as a
customer or serve as a
supplier
The more focused the
product ontology, the
more structured and
goal-oriented the
management of the
product development
project portfolio
The narrower the firm’s beliefs in its operational
boundaries, the fewer are
its unique resources and
competencies.
Managerial cognitions of
current and future product
ontologies is a major
constraint and reinforcer
in the evolution of
product/service offerings
The stronger the industry
recipe, the more uniform
process architectures will
be across competing fir ms.
Operations
Finance & Accounting
Industry recipe
The stronger the cognition
of reputational rankings,
the more uniform the
capital budgeting and
financial reporting
practices of competing
fir ms .
The firm’s cognition of its boundaries constrains its
use of management
accounting practices and
financial instruments.
T able 1: 10 propositions about the business model of the firm: relationships between
material aspects and the belief system
In our conceptualization of the business model, the interrelationship between organizational
culture and the cognitive belief system of the firm is strong. Organizational culture seems to
be defined by the different levels of the belief system. As corporate culture literature
acknowledges, firms can be conceptualized according to whether they emphasize reputation,
identity, membership in a group or the substance of their actions. The culture in organizations
thus creates structures, routines, and hierarchies that facilitate their systemic functioning and
motivates organizational actors to, for example, embrace the strategic intent of the firm
(Schein, 1985; Pettigrew, 1979).
There are, however, clear aspects of culture that can be measured objectively and should thus
be related to the belief system. For example, the extent to which managers exercise strategic
foresight and/or the level of intrapreneurship in a firm can be assessed. It would be necessary
22
to study the relationships between the more ‘material’ aspects of corporate culture and
managers’ perception of the firm in a similar way in which other material aspects have been dealt with in this paper. Given the broad field of corporate culture research, it is not easy to
put forward propositions about these linkages without structuring our approach to the
corporate culture discourse.
Researchers may weigh the importance of individual components or their interplay in the
evolution of business models in different historical situations and contexts. This research
work may, in turn, lead to more simplified presentations of key success factors or drivers of
failure in different industry and company contexts. On the basis of further field studies, it
remains to be seen whether our broad conceptualization can be reduced to a more simplified
form, still capable of addressing the key issues in the evolution of the business model of a
firm.
Implications for Practitioners
Despite the evident ambiguity of the business model concept, it has been widely used to refer
to the logic and functioning of a firm. Earlier research has often reduced the concept to a
limited number of components (e.g. economic logic, routines, resources) argued to explain
most of the success or failure of individual business models (Winter and Szulanski, 2001;
Amit and Zott, 2002).
In this paper, in contrast to these reductionist tendencies, we have provided a wide-ranging
conceptualization of the material, cognitive and evolutionary aspects of the business model of
a firm. Consequently, our main contribution is the enrichment, extending and redefinition of
the business model concept. Moreover, we argue that the framework and the related
propositions also possess value for managerial interpretation and reflection.
The proposed framework is simplistic and may not include some potentially relevant issues in
the evolution of firms’ business models. Nevertheless, we believe the constructed framework sufficiently identifies the ‘high priority’ elements of the business model of a firm, pegging them to research in the distinct specialisms of management from strategy to accounting and
23
finance. Disregarding the issue of potential theoretical incommensurability arising from such
an eclectic effort, we argue that in real-life business models, the identified elements are
inherently interconnected.
The business model framework has tangible benefits to practitioners:
(1) Through the business model framework, practitioners can investigate the evolution of
their business models. The business model framework provides a conceptual tool for
firm-level management that also addresses operational issues. The link between
operative decisions and issues regarding the business model components build a
bridge between strategic and operative management and, arguably, between middle
and top management.
(2) The business model framework is systemic. It demonstrates that firm processes
emerge from each other and their coordination is key to maintaining competitive
advantage. The major implication to management is that strongly developing one
component of the business model always has network effects to other components. For
example, the developing of management accounting nearly always has implications on
operations management. Likewise, strategic realignment that does not fit the other
components is doomed to fail.
(3) The business model is a cognitive mechanism. This implies that managing the
business model in practice always has a link to human resource management and the
management of perceptions. Despite the fact that the business model framework is an
abstract conceptualisation, it essentially deals with pragmatic ‘sense-making’ issues. This
offers
practitioners
an
alternative
tool
to
conventional,
prescriptive
‘organizational design’ thinking.
(4) Finally, the business model framework has proven to be a useful tool in business
education. It encapsulates the key areas of management and contextualizes them in the
realm of managerial action.
24
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