The Business Models Investors Prefer

Image courtesy of Flickr user alvazer.

Why are investors so bullish on companies like Apple and Disney? Is it financial metrics, great management, industry prowess, good investor relations or good timing? Probably all of these. But something else may be at work, too. In research we conducted at the MIT Sloan School of Management, we found that the stock market consistently values certain types of business models more highly than others. Specifically, we found that in recent years, investors have favored business models focusing on licensing intellectual property (such as Walt Disney’s business model) and a certain kind of highly innovative manufacturing (such as Apple’s).

We developed a framework that includes 14 types of business models. (Surprisingly, we found there is no universally accepted definition of the important concept of a business model.) Then, using data from Compustat, we classified all the more than 10,000 companies that are publicly traded on U.S. exchanges within the framework by identifying the percentage of each company’s revenue generated through each of the 14 business models; we used a combination of manual classification and a custom-developed rule-based software program. By classifying companies’ revenue into these 14 business models, a new picture emerged of not only individual companies, but businesses more generally. The individual classifications were then aggregated to construct an index for each business model. Those indices then allowed us to compare total stock market returns — as measured by changes in stock price plus dividends — for different business models in the U.S. markets over a 12-year period, from 1997 through 2009. The results provide insight into investor treatment of various business models. In particular, the findings underscore the importance of innovation and intellectual property in the U.S. economy.

Our business model framework is based on defining the types of assets a company sells and the rights it grants customers to use those assets. We define four asset types and four ways companies manage asset rights to generate revenue.