Startups Wanted: A Cost-Effective Route to Business Model Innovation for Established Companies

For many large companies, collaborating with startups has become essential. Initially driven by the allure of startups' agile methods, this collaboration has evolved into a strategic approach for business growth. Partnering with startups offers a cost-effective way to explore new technologies, markets, and skills—crucial elements for innovation in Horizon 2 or 3 and beyond the current core business model. In this blog, we explore the best route to successfully test and innovate entirely new business models by leveraging startup partnerships.

Developing and launching an entirely new business model is risky.

• First, creating a business model distinct from the prevailing one requires acquiring new insights into markets, technologies, skills, and regulations.
• Second, new business models require substantial investments to develop an attractive value proposition and to ensure it aligns with both value creation and appropriation mechanisms.
• Third, the novelty of these models brings inherent uncertainties about whether the investments will yield the desired returns.
• Lastly, these new models could potentially disrupt the existing core business model, leading to hesitation, risks, and insecurity among stakeholders.

Consequently, there is a need for a business model innovation strategy that reduces investment costs, facilitates rapid knowledge acquisition, and allows for quick, low-risk testing of new ideas. This creates the perfect scenario for substantial corporations to engage in partnerships with startups.

Startups are often in the process of refining their own business models, making them ideal partners in this context. They seek access to greater resources, extensive partner networks, and new market opportunities—elements that large companies can provide. This symbiotic relationship allows startups to scale their operations, boost production capabilities, and extend their market reach more effectively and efficiently than on their own.

Conversely, for established companies, the cost benefits of collaborating with startups are significant. They avoid the pitfalls of starting from scratch and incurring high sunk costs. Moreover, the typically efficient but rigid operational systems of large organizations can impede the swift adaptations required for testing and evolving new business models. Thus, many corporations have established dedicated startup scouting and venturing teams, optimizing their strategies for startup collaboration. The recent rise of venture clienting illustrates how quickly and effectively these collaborations can be initiated.

Creating new business models

For most companies, enhancing the current core business model remains the primary strategy for business model innovation. Competitive pressures and operational demands compel these companies to invest heavily in their core business models to maintain competitiveness and operational efficiency.

This approach aligns with the 70:20:10 rule of innovation, which advises that more than two-thirds of innovation capital should be allocated to core improvements to avoid falling behind in the market. Yet, companies with greater ambitions, aiming to outperform market growth, recognize the necessity of embracing higher-risk investments. This might involve expanding their current business models (known as Horizon 2 innovation) or developing entirely new models (Horizon 3 innovation).

Business model innovation in Horizon 2 and Horizon 3 often entails significant modifications to one or several elements of an existing business model or the introduction of a completely new model. This could include redefining your target audience and how your company’s value proposition meets its needs. Alternatively, it could involve a shift in operational logic—for example, transitioning from manufacturing to partnering, enhancing operational efficiency, or shifting revenue strategies from direct sales to renting or licensing.

These considerations are encapsulated in a business model, typically illustrated using a business model template that outlines the three key components: value creation, value delivery and proposition, and revenue/value capture. Our Business Model Innovation Toolkit offers a free-to-use template and details the six most commonly employed strategies for business model innovation.

It's evident that the more varied and extensive the changes to the existing business model, the greater the uncertainty becomes. Established companies, having perfected their business operations and developed highly efficient systems, often view changes with skepticism and hesitation—especially when their current model generates consistent, high revenue.

For these organizations, pursuing Horizon 2 and Horizon 3 business model innovations is seen as risky and expensive, as it requires the acquisition of new knowledge and capabilities. Moreover, current robust income streams set high benchmarks for any new business model and can lead to unrealistic expectations from management.

Startup collaboration for business model innovation

By definition, innovating in Horizon 2 and Horizon 3 involves venturing into areas with limited existing knowledge, whether that pertains to new technologies or unexplored market domains. In these cases, the acquisition of new knowledge is essential. Established companies have the option to develop this knowledge internally or to seek it through partnerships with startups. The choice between building capabilities internally or collaborating depends on the strategic importance of the focus topic. For topics in which innovation could serve as a key competitive differentiator, companies often prefer to develop the required capabilities in-house.

For established companies, collaborating with startups represents a compelling innovation engine for exploring areas beyond their core business model, especially for focus topics that are promising yet not critical to business operations. Startups often possess specialized knowledge in niche areas, making them ideal partners. Their collaboration offers a cost-effective method for larger companies to acquire deep expertise and innovative technologies.

Additionally, since startups are typically seeking a scalable operational model, they tend not to rely on highly complex systems, making it easier for them to adapt their business models. This not only simplifies the process but also reduces costs for established companies, as no entirely new product lines need to be developed until initial tests prove successful.

Startups typically begin by interacting with a smaller user group, which means that any failures have a narrower impact compared to those experienced by established companies. They also benefit from their status as the “new kid on the block,” captivating customers without the burden of pre-existing expectations. For established companies, this brings the advantage of unbranded testing. Consequently, any failures in the validation and testing process will not tarnish the established company's brand image or negatively affect the core business model.

These advantages underline why startup collaboration has emerged as a practical strategy for business growth among established companies. However, engaging in startup collaboration for business model innovation is not without costs. Operational expenses related to partnerships are just the beginning; significant resources are also required in the early stages of startup exploration and selection.

For example, Bosch annually reviews over 1,000 collaboration proposals, all of which must be carefully scanned and assessed. Additionally, to validate and refine business models, startups may receive funding from larger companies. For such collaborations to be effective, it is crucial for established companies to maintain a robust operational framework, complete with clear criteria for scouting and funding.

To optimize the readiness of established companies for startup collaboration, we have compiled the most important criteria in a checklist:

How to test new business models with startups

Startups are constantly seeking scalability in their business models. This pursuit creates opportunities for established companies to form partnerships and explore new technologies or market sectors. However, it also means that aspects of the startup's business model may still be under development and require validation or further iteration. The process of business model validation involves gathering sufficient evidence to confirm that the new business model is desirable, viable, and feasible.

• Desirability assesses whether there is a real need for the product or service. It involves determining if the target audience faces a problem that the business can solve and how strongly they desire a solution.
• Viability examines whether customers are willing to pay for the solution, thus determining if a sustainable business can be established.
• Feasibility focuses on the ability to produce and deliver the solution cost-effectively.

Together, these factors help determine whether the business model can scale and generate substantial new profits and growth.

Given the limitations of operational and financial resources and the importance of first impressions, it is advisable to test desirability, viability, and feasibility through small, real-world business model experiments. These experiments are structured approaches designed to test the assumptions underlying a business model. They aim to reduce uncertainty and risk and guide decision-making through empirical evidence. Central to each experiment are one or more hypotheses that need validation.

Good business hypotheses share three key traits: they are testable, targeted, and exclusive.

• A hypothesis is testable if it can be validated or refuted through collected data, necessitating the establishment of threshold values to determine if the hypothesis holds.
• It is targeted if it clearly specifies what is being tested, with whom, and under what circumstances. This means establishing the environment and boundary conditions for testing the hypothesis.
• Finally, a hypothesis is exclusive if it focuses on a single, clear, and testable aspect of the business model.

Potential hypotheses for testing in business model innovation might include variations in value proposition messaging to target audiences, pricing strategies, distribution channels, or scalable production and distribution methods. To assist in documenting the evidence gathered during this stage, we offer a free Business Model Validation Template.

All else being equal, the startup could, for instance, run two A/B tests to determine the most compelling value proposition message. By setting up two web pages with different value statements, the startup can analyze the click-through rates to identify which message resonates more with visitors.

Similarly, the startup could explore various production methods to find the most cost-effective yet efficient way to manufacture goods. Minimum viable products (MVPs) are crucial for such tests, as they represent the simplest version of a product, focusing only on essential features and allowing for rapid iterations. This approach enables companies to maximize their learning about customer preferences with minimal effort.

In short, business model experiments are vital because they allow companies to test their concepts before fully committing substantial resources. By validating assumptions and refining strategies based on empirical data, companies can significantly reduce risks and enhance the chances of success for their business model. This is especially beneficial in the context of startup collaborations and testing new business models.

As a general guideline, business model experiments should commence by validating the desirability—assessing whether there is a demand for a new business model. This requires customer-centricity, understanding customer issues and needs, and evaluating how much a new business model alleviates these pain points. Starting with desirability is crucial because, without identified demand, any further investments would be squandered.

Different opinions exist, such as the belief that asking customers directly might yield good ideas but not innovative leaps and radical innovation. This concern is real and has arisen due to the common method of using interviews to gather customer feedback. Instead, as emphasized in methodologies like design thinking, companies should observe customer behaviors and infer insights from these observations. Such studies, whether qualitative or through big data analysis, provide more unbiased and natural insights into what truly engages or frustrates customers.

Following these data-driven insights, companies can then develop simple and rapid prototypes to compare new offerings against existing ones, thus validating their viability. If a new offering proves appealing enough to be chosen and purchased over current options, the company may then proceed to assess technical feasibility and make more substantial investments. Until then, rapid prototypes such as mock-ups, click dummies, or demonstrators suffice.

Testing for feasibility should only commence once the MVP has been developed into a more complete product ready for market launch. Each iteration during this phase should gather evidence on which features are essential and which are merely nice to have. As the product develops, it may be necessary to reevaluate its desirability and viability with the revised design.

Ultimately, the validation of a business model should proceed in order of lowest investment and risk. This means validating desirability first, viability next, and finally feasibility.

In a nutshell: Advantages and hurdles of startup collaboration for business model innovation

In conclusion, collaborating with startups is a practical strategy for business growth among established companies committed to pursuing innovations in Horizon 2 and Horizon 3. The key points to keep in mind include:

1. Benefits of collaboration: Startup partnerships offer access to new technologies, markets, and skills. Established companies can leverage these relationships to experiment with new ideas, especially those beyond their core business.
2. Usefulness of startup collaboration: As collaborating with startups also has its costs, only companies with strong growth ambitions beyond their core or disruptive industry clock speeds should use this tactic and expend the resources needed to manage the relationships.
3. Risk reduction: Developing new business models is inherently risky, involving the acquisition of new knowledge and significant investments. Collaborating with startups offers a faster and more cost-effective method for testing these models. By partnering with startups, established companies can protect their brands from potential failures associated with testing new ideas, as any negative outcomes are less likely to impact the established company's core brand.
4. Selection criteria: It is crucial for established companies to carefully select their startup partners, ensuring that the costs of exploration are balanced and aligned with strategic priorities. The validation of startup business models should focus on desirability (market demand), viability (business sustainability), and feasibility (production efficiency).
5. Validation process: The process of validating a business model should start with evaluating its desirability, followed by its viability, and concluding with its feasibility. Employing iterative prototyping, MVPs, and real-world testing minimizes risks while enhancing the learning process.

When should you build a specific startup collaboration unit?

If you have the means to establish a venture client unit or call it whatever you like, […] just do it, simply because I think it helps you as the organization to stay head to toe with competitors about innovations, technologies, et cetera.

Enhancing business model innovation and startup collaboration with ITONICS

The ITONICS Innovation OS excels in seamlessly integrating the exploration of innovative startups with the planning, development, and validation of business model innovation across various stages and criteria.

This system enables companies to efficiently gather, assess, and utilize challenges from business units for effective startup collaboration, laying a solid foundation for effective startup collaboration. It simplifies identifying the most promising startup partners from a broad pool of candidates using a structured approach, aligning startup solutions with specific business unit challenges and opportunities. Our use case on startup scouting with ITONICS offers further insights into this process.

Similar to customer relationship management (CRM), managing startup relationships involves understanding the status and performance of all partnership activities. ITONICS supports this with advanced phase-gate management, collaborative evaluations, performance analytics, and detailed reporting. Assessing and reevaluating multiple partnership opportunities from a risk perspective is critical. ITONICS integrates risk management into startup relationship management, enabling effective oversight of risk portfolios.

By leveraging these capabilities, ITONICS Innovation OS not only simplifies complex innovation processes but also equips organizations to navigate the evolving market landscape confidently, turning potential challenges into opportunities for strategic growth.