Testing Business Model Hypotheses: Going beyond Customer Development

In an interesting post of Steve Blank, where he relates Customer Development to the Business Model Canvas, he states that ‘Customer Development is the standard for testing business model hypotheses.’ While I understand the central role of being customer-driven, as a business model’s primary focus is on creating customer value, this seems to address only one side of the coin.

While the customer-facing part of the business model is of extreme importance, the other parts should not be neglected. It is the whole system that enables the creation of customer value and creates an incentive to do so. This is also why business models are multi-disciplinary bringing together marketing, operations, finance, etc. So in addition to testing the customer hypotheses, we also need to test, for example, the operational hypotheses related to can we produce the kind of offering required at the expected quality and for the targeted costs?

In addition, in my view a business model has the power of being an integrative conceptualization of value where value creation and capture are linked and where the customer and provider perspectives are merged. This means that the most important hypotheses are the once that say something about the relations in the business model. For example, how can the Value Proposition be turned into a Revenue Stream? How can the Key Activities, Key Resources and Key Partners deliver a compelling and unique VP? How can we make sure that we it is all worthwhile (Revenue Streams >> Cost Structure)?

Understanding and defining the value proposition

One of the most important elements of the business model is the value proposition. But while we intuitively all know what it means, writing it down for a concrete case can be a challenging and confusing exercise. So I decided to do some research to get some advice and ideas on this. Surprisingly, while value propositions are widely discussed, I found it hard to find literature discussing more in depth what a value proposition actually is. Most interestingly, the most prominent hit is Kaplan and Norton from the Balanced Scorecard.

According to Kaplan and Norton (2000) the customer value proposition describes ‘the unique mix of product and service attributes, customer relations, and corporate image that a company offers.’ It defines how the organization can differentiate itself from competitors to establish and develop relationships with its target customers. Kaplan and Norton argue that a value proposition is critical for linking the internal organization to improved customer outcomes. They differentiate between three types of differentiators based on the value disciplines of Treacy and Wiersema(1993): operational excellence, customer intimacy, and product leadership.

Anderson, Narus and Van Rossum (2006) state that when value propositions are properly constructed, ‘they force companies to rigorously focus on what their offerings are really worth to their customers’. This will also enable companies to make smarter choices about where to allocate their scarce resources in developing new offerings. Anderson et al. discuss a classification of three types to sort the value elements of a company’s offering: points of parity, points of difference, and points of contention. They have identified the three ways in which companies use the term ‘value proposition’: all benefits, favourable points of difference, and resonating focus. In the first approach companies simply list all the benefits the target customers receive from the company’s offering. In the second approach the company explicitly recognize that the customer has an alternative and they list all favourable points of difference that the company’s offering has relative to the next best alternative. In the third approach the company shows a full understanding of the critical issues of their customers who are often managers with ever-increasing levels of responsibility and pressured for time. The company makes their offering superior on a few elements that matter most to target customers and convey this in a communicative and evidence-based way.

Anderson, J. C., Narus, J. C., & Van Rossum, W. (2006). Customer value proposition in business markets. Harvard Business Review, 84(3), 91-99.
Kaplan, R. S., & Norton, D. P. (2000). Having Trouble with Your Strategy? Then Map It. Harvard Business Review, 78(5), 167-176.
Treacy, M. E., & Wiersema, F. D. (1993). Customer Intimacy and Other Value Disciplines. Harvard Business Review, 71(1).

On the ‘value’ in business model definitions

As ‘value’ is one of the most common term in business model definitions, the obvious question is what is meant with value? Surprisingly, it is almost never further elaborated or discussed in business model books or articles. In general the term ‘value’ is used to refer to ‘the quality (positive or negative) that renders something desirable or valuable’ (Wordnet 3.0) or ‘something (as a principle or quality) intrinsically valuable or desirable’ (Merriam-Webster).

It seems that when business model definitions refer to value, they mostly mean customer value (such as, Afuah, 2004; Dubosson-Torbay, Osterwalder, & Pigneur, 2002; Tapscott, 2001), while some refer to value for both the customer and the company (e.g., Bouwman, De Vos, & Haaker, 2008; Johnson, 2010). Mostly the value for the company (and other providers in the case of an inter-organizational network) seems to be implicit in the definition by referring to capturing (customer) value. This raises the question what is meant with customer value.

Weinstein and Johnson (1999) state that the concept of customer value is as old as ancient trade practices and refer to the early barter transactions where buyers would carefully evaluate the offerings of sellers. Buyers would only agree to close a deal when the benefits (products received) compared to the cost (items traded) were perceived as being a fair (or better) value. Hence, customer value is ‘the satisfaction of customer requirements at the least total cost of acquisition, ownership, and use’ (De Rose, 1994 cited in ; Weinstein & Johnson, 1999)

Woodruff (1997) defines customer value as ‘a customer's perceived preference for and evaluation of those product attributes, attribute performances, and consequences arising from use that facilitate (or block) achieving the customer's goals and purposes in use situations.’ Woodruff proposes a ‘customer value hierarchy,’ which is a means-end type of model where the desired customer value moves from desired product attributes and attribute performances, via desired consequences in use situations, to customers’ goals and purposes. Woodruff also notes that the use situation plays a critical role in customer evaluation as well as in desires. This means that customer value is highly subjective and contextualized.

Customer value is also described as value-in-use (or use value), which is value created with and determined by the user during the consumption process (Bowman & Ambrosini, 2000; Grönroos, 2006; Lusch & Vargo, 2006). This is differentiated from value-in-exchange (or exchange value), which is value embedded in the product itself (i.e. added during the production process) and determined at the point of exchange (Bowman & Ambrosini, 2000; Grönroos, 2006; Lusch & Vargo, 2006). This brings us back to the definition of business models, as creating value relates to value-in-use and capturing value relates to value-in-exchange (Priem, 2007).

Afuah, A. (2004). Business models: A strategic management approach. New York, NY: McGraw-Hill/Irwin.
Bouwman, H., De Vos, H., & Haaker, T. (2008). Mobile service innovation and business models. Heidelberg, Germany: Springer.
Bowman, C., & Ambrosini, V. (2000). Value creation versus value capture: Towards a coherent definition of value in strategy. British Journal of Management, 11(1), 1-15.
De Rose, L. (1994). The value network: Integrating the five critical processes that create customer satisfaction. New York, NY: AMACOM.
Dubosson-Torbay, M., Osterwalder, A., & Pigneur, Y. (2002). E-business model design, classification, and measurements. Thunderbird International Business Review, 44(1), 5-23.
Grönroos, C. (2006). Adopting a service logic for marketing. Marketing Theory, 6(3), 317-333.
Johnson, M. W. (2010). Seizing the white space: Business model innovation for growth and renewal. Boston, MA: Harvard Business Press.
Lusch, R. F., & Vargo, S. L. (2006). Service-dominant logic: Reactions, reflections and refinements. Marketing Theory, 6(3), 281-288.
Priem, R. L. (2007). A consumer perspective on value creation. Academy of Management Review, 32(1), 219-235.
Tapscott, D. (2001). Rethinking strategy in a networked world: Or why Michael Porter is wrong about the Internet. Strategy + Business, 24, 1-8.
Weinstein, A., & Johnson, W. C. (1999). Designing and delivering superior customer value: Concepts, cases and applications. Boca Raton, FL: CRC Press.
Woodruff, R. (1997). Customer value: The next source for competitive advantage. Journal of the Academy of Marketing Science, 25(2), 139-153.