Regulatory affect on business model success: The California smog check program

Abstract

There has been a lack of economic scholarly research on business model innovation, and minimal research on how regulatory conditions impact business models. Regulations create market demand (henceforth known as Artificial Demand) that would not have existed without the enactment of the regulation. Managers need guidance in understanding how changing consumer needs in a regulated market could affect business model design, and how to optimize business model design in new markets created by regulation. A quantitative study was conducted on the California vehicle emissions testing industry (Smog Check program), and found that the business model focusing on meeting the minimum regulatory requirements was financially superior to the traditional incremental business model. The study found that: (a) business models have their own S-curve, (b) regulatory created markets have a different S-curve than traditional markets, (c) targeted artificial demand can be directed to a specific business model by government agencies, (d) changes in regulation appear to correspond to changes in market revenues, (e) spikes in the industry S-curve correspond to regulatory action, (f) legislation is able to prop up a market from a decline, (g) a negative growth rate over the life of a market appears to be an attribute that might only be able to be found in regulatory created markets. The study also appears to be the first scholarly research to quantitatively link a regulation to the creation of a new market. The concept of Artificial Demand Theory has been proposed that captures the unique attributes uncovered in this study.