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CFA Level I Exam · Business Models

Business Model Risks, Innovation and Sustainability

Updated 7 October 2026 · Fact-checked

A business model describes how a company creates, delivers and captures value. Its risks come from competition, disruption, weak moats, customer concentration and changing rules. To answer exam questions, identify the value source, test how durable the advantage is, then judge whether innovation or disruption strengthens or erodes long-term cash flows.

Understand Business Model Risks, Innovation and Sustainability

A business model explains how a company makes money: who its customers are, what it offers, how it reaches them and how it earns revenue and profit. Business models are not fixed. Technology, regulation, customer tastes and rivals all force them to change over time.

A competitive advantage is something that lets a firm earn returns above its cost of capital for a long period. Common sources are cost leadership, differentiation (brand, quality, features), network effects, switching costs, scale, intellectual property and access to scarce resources. An advantage is only useful if rivals cannot copy it quickly. Analysts often call a durable advantage a moat.

Business model risks are the ways the model can fail. Examples: heavy reliance on a few customers or suppliers, a single product, a single country, a technology that may become obsolete, regulatory change, and a model that depends on cheap financing. Risks also include execution risk when a firm changes its model, for example moving from selling software licences to selling subscriptions.

Disruption happens when a new entrant or technology serves customers in a different, often cheaper or simpler, way and then moves upmarket. Incumbents may ignore it at first because early profits look small. Innovation is the response or the cause: new products, new pricing, new channels or new cost structures. Innovation can renew an advantage, but it costs money and may fail.

Sustainability has two meanings in this topic. First, can the model keep producing profits and cash flow over many years (long-term viability)? Second, does the firm manage environmental, social and governance factors that could damage the model through fines, lost customers or higher funding costs? For valuation, a durable advantage supports higher growth and longer high-return periods. A disrupted or unsustainable model means lower expected cash flows, higher risk, or both.

How to solve Business Model Risks, Innovation and Sustainability questions

Use this sequence for any question on business model risk, innovation or sustainability. No calculation is usually needed; the task is classification and judgement.

  1. 1Identify how the firm creates and captures value: customers, offering, channels and revenue model.
  2. 2Name the source of competitive advantage (cost, differentiation, network effects, switching costs, scale, IP).
  3. 3Ask how easily rivals or new technology could copy or bypass it. If easily, the advantage is weak.
  4. 4List the specific risks in the facts given: concentration, regulation, obsolescence, financing, execution.
  5. 5Decide whether the described change is sustaining innovation (improves the current model) or disruptive (changes who competes and how).
  6. 6Link the conclusion to long-term viability and valuation: durable advantage means more stable or higher cash flows; erosion means lower cash flows or higher risk.
  7. 7Match your conclusion to exactly one of the three options and check the other two for wrong cause-and-effect.

Quickest way: Moat, threat, response

When to use it: Use for most qualitative stems when you have about 90 seconds and need a fast choice among three options.

  1. Find the moat in the stem in one phrase.
  2. Find the threat: new entrant, new technology, rule change or customer loss.
  3. Check whether the firm's response is credible and funded.
  4. Eliminate any option that says the advantage is permanent or that innovation guarantees success.
  5. Eliminate any option that mixes up cause and effect, such as higher risk leading to a lower required return.
  6. Pick the remaining option.

Common mistakes in Business Model Risks, Innovation and Sustainability

  • Treating any large market share as a durable competitive advantage.

    Size looks like strength, so students stop analysing.

    Fix: Ask whether the share is protected by switching costs, network effects, cost advantage or IP. Share alone can be competed away.

  • Assuming innovation always raises value.

    Innovation sounds positive.

    Fix: Innovation costs cash and can fail. Value rises only if it renews the advantage or earns returns above the cost of capital.

  • Confusing sustaining and disruptive innovation.

    Both involve new products.

    Fix: Sustaining innovation improves the existing model for existing customers. Disruptive innovation starts in a simpler or cheaper way, often at the low end or a new segment, and later threatens incumbents.

  • Reading sustainability only as environmental issues.

    The word is linked to climate in the news.

    Fix: Also cover long-term viability of profits and the social and governance factors that can hurt the model.

  • Ignoring concentration risk because current profits are high.

    Strong results hide dependence on one customer, supplier, product or region.

    Fix: Treat concentration as a risk even when margins are good. Loss of one party can break the model.

  • Picking an option with absolute words like 'always' or 'eliminates'.

    Students want a clean rule.

    Fix: Business model outcomes are conditional. Prefer options that state a tendency or condition.

Worked examples

Example 1

An analyst reviews a global payments platform. Its value rises as more merchants and consumers join, and users rarely leave because their transaction history and stored details are on the platform. Which statement best describes its competitive advantage? A. Cost leadership from lower input prices. B. Network effects and switching costs. C. Protection from a single patent.

Show the solution
  1. Value rises as more merchants and consumers join: this is a network effect.
  2. Users rarely leave because history and stored details are on the platform: this is a switching cost.
  3. Nothing in the stem mentions input prices, so A is unsupported.
  4. Nothing mentions a patent, so C is unsupported.

Answer: B. Network effects and switching costs.

Example 2

A traditional bank earns most profit from branch-based fees. A new entrant offers simple app-based accounts at lower cost to small customers and slowly adds more services for larger customers. Which statement is most accurate? A. The entrant is a sustaining innovator and poses no threat. B. The entrant is a disruptive competitor and may erode the bank's long-term profits. C. The bank's advantage is permanent because it has branches.

Show the solution
  1. The entrant starts with a cheaper, simpler model for a small segment and then moves up to larger customers. This is the pattern of disruption.
  2. So A is wrong: a sustaining innovation improves the existing model for existing customers, and the stem does not say that.
  3. Branches are an asset but not a guaranteed moat if customers prefer apps. C uses 'permanent', which overstates.
  4. Eroding profits from a lower-cost rival is the logical effect on the incumbent's long-term viability and valuation.

Answer: B. The entrant is a disruptive competitor and may erode the bank's long-term profits.

Exam tips

  • Watch for absolute words such as 'always', 'guarantees' and 'permanent'. They usually mark a wrong option.
  • Link every business model point to cash flow and risk, because the exam tests how it affects valuation and viability.
  • Be able to name sources of competitive advantage from short descriptions in the stem.
  • Tell sustaining from disruptive innovation by who the first customers are and how the cost structure differs.
  • Read each option for reversed cause and effect before choosing.

Practice questions from Business Models

Business Model Risks, Innovation and Sustainability in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Business Model Risks, Innovation and Sustainability: frequently asked questions

What are the main business model risks in CFA Level I?

They include customer, supplier or product concentration, technology obsolescence, regulatory change, weak or copyable competitive advantage, financing dependence and execution risk when changing the model. Questions ask you to spot the risk in a short description.

How do disruptive business models affect valuation?

Disruption can lower an incumbent's expected growth and margins and shorten the period of above-average returns. That reduces expected cash flows or raises risk, so value falls. For the disruptor, value depends on whether it can scale profitably.

What is the difference between a competitive advantage and a business model?

The business model is how the firm creates, delivers and captures value. A competitive advantage is the feature within it that lets the firm earn above-normal returns and that rivals cannot easily copy.

Does business model sustainability only mean ESG?

No. It covers whether the model can keep producing profits and cash flow over the long term, and also how well the firm handles environmental, social and governance factors that could hurt that model.