Business Models and the Theory of the Firm Working Paper No. 32 Bruce Rasmussen Pharmaceutical Industry Project Working Paper Series June 2007 Centre for Strategic Economic Studies Victoria University of Technology PO Box 14428 Melbourne VIC 8001 AUSTRALIA Telephone +613 9919 1340 Fax +613 9919 1350 Contact email: bruce.rasmussen@vu.edu.au

PIP Working Paper No. 32 1 Business Models and the Theory of the Firm Bruce Rasmussen Introduction The concept of a business model facilitates analysis of the way in which a firm derives economic value from a newly developed technology. Indeed Chesbrough and Rosenbloom (2002) have argued that it is the business model adopted, more so than the technology itself, which is critical to the success of the commercialisation of new technology. The concept is concerned with how the firm defines its competitive strategy through the design of the product or service it offers to its market, how it charges for it and what it costs to produce. How it differentiates itself from other firms by the nature of its value proposition. It also describes how the firm integrates its own value chain with that of other firms in the industry���s value networks. One of the difficulties of employing the business model concept is that it is still in its infancy in academic usage. It owes its origins largely to pragmatic development and use in the business sector. Chesbrough and Rosenbloom (2002) quote a May 2000 search of the Web which found 107,000 references to the term ���business model��� in general use while a search of the academic literature (Econolit1) found only three references to the term. The purpose of this paper is to outline some of the business origins of the concept, define the business model as well as possible from the academic literature and finally, use the theories of the firm to enrich its predictive powers as to whether the model will create value. The business need for a business model The concept of the business model is strongly associated with the emergence of e- commerce and other new economy businesses. It grew out of a need to encapsulate the essential features of a business in a short descriptive document in order that a judgement could be made, for example by potential investors, on whether the business was likely to achieve its financial and other objectives. In this context the business model is designed to answer a series of questions essential to any business ��� who are the customers, what do they value, how that value can be delivered to the customer at an appropriate cost and how the business deploys its assets. It includes a description of the key assets, both physical and intangible such as intellectual property, governance structure and management. It consists of both a narrative of how the business works and the numbers ��� how it makes a profit. The concept came into vogue when the spreadsheet provided an easy way to test the financial implications of the narrative in a financial model which contained assumptions about costs, product demand, sales revenue and profit. The financial 1 The American Economic Association���s electronic bibliography, EconLit, indexes more than thirty years of economics literature from around the world (http://www.econlit.org/).