Business Models / By
Business model. Those two words are used by academics, business gurus and entrepreneurs – but exactly what is a business model?
A simple way to think of what is a business is to think about it in three parts:
- What are you creating – can you create something that customers want to buy – Feasability.
- Who are you go to market and sell it to? why will they want to buy it? – Desirability.
- The revenue model – how much does it cost to produce and market and how much will we make – is it profitable? – Viability.
Creating and capturing value is – what do you produce (create value) and how much are customers willing to pay for that (capture value).
The value proposition is how you explain and communicate to customers what’s in it for them – why they should buy.
More specifically, business models refer to all of the activities you do in a firm, and the partners you use, to create your products or services and how you then distribute and market to your customers.
Underlying all of this is the revenue model, that is how you make money after you have paid for goods, employees and other resources and activities.
Don’t worry too much now about the definition of the business model. I’ve included loads of examples, plus some handy resources to help you understand it and use it.
Let’s begin.
If you aren’t clear about your business idea, your business model, then others won’t invest in your business.
A business model helps you to clearly express how the pieces of your business come together to create a product or service that customers will buy and enable you to make a profit.
Why A Business Model Is Important?
A business model is a more effective way to compete because it is hard for competitors to copy a business model but relatively easy to copy a product or service.
If you’re starting a new business and want to immediately get traction with customers then you need to have an unbeatable business model.
Likewise, if you already manage a business but need to grow, then a powerful way to kickstart your ideas is to focus on reinventing your business model.
In this article, I will walk you through what is a business model and how to create one. This simple guide will help you master the art and science of designing your own business model.
This is why business modeling has become so popular. A business model helps you to take your business idea and think about deeply, explore different options and then pick the best solution.
What is the best solution? Ideally, we want a business that has unique features – an unfair advantage – that others can’t easily copy. Later in this article, we’ll take a look at why some business models are more successful than others.
Let’s take a deeper look into what is a business model and why it is important.
The Business Model Explained
A business model is a framework to understand, design, and test your business idea. It provides a systematic way to identify how you can profitably generate revenue while creating value for your customers.
There is no one definition of what is a business model.
In the academic community, a business model is seen as a concept that lacks clarity. Many even think it shouldn’t even exist as a standalone topic and area of research. In fact, the one thing that academics do agree on is that there is no single definition of what is a business model.
However, in the real world, the business model has been used by hundreds of thousands of people. It has now become one of the most powerful forces for change and has given rise to a movement.
More and more people now use the business model design to shape their ideas and turn them into thriving businesses. But, it isn’t just entrepreneurs that have benefitted.
Large organizations, government institutions, and brands have used the business model approach to transform how they operate and reframe how they meet the needs of customers.
Harnessing the power of the business model generation has become a competitive necessity as the pace of change increases.
In recent years, the popularity of business models has given rise to lots of different business modeling frameworks. Some of which move beyond the normal concerns in business design, and consider issues such as sustainability and the circular economy.
These and other business model frameworks are covered in this guide.
Whether you are a startup or an executive in a large corporate brand, harnessing the power of business models and business model innovation is now a crucial skill.
Who Created The Business Model?
The roots of the business model concept can be traced back to as early as 1954, when Peter Drucker (Drucker, P. (1954), defined a good business model as one that answers the following questions:
Who is the customer?
What does the customer value?
How do we make money?
What is the underlying economic logic that explains how we can deliver value to customers at an appropriate cost?
The first academic article using “business model” in its title was written in 1960! 1
Since then many people have tried to define what is a business model. As an example, Michael Lewis in his book the New, New Thing simply says that it is: “…how you plan to make money”. Further on in the book, he even refers to the business model as “a term of art.”
Joan Magretta describes a business model as a story that helps people to understand what a company does and how it does it.
But, perhaps the most post popular, and commonly used understanding of what is a business model comes from Osterwalder and Pigneur who created the Business Model Canvas. The business model canvas is a visual representation of a business broken down into 9 sections.
At the heart of the business model is the value proposition. The value proposition is how you create value for a specific set of customers. The other parts of the business model are about what resources you need, how you will reach your customers and how a company entices them to pay for value and converts those payments into profit.
The value proposition determines the WHY. Why will customers buy your solution? What’s in it for them? How do they benefit?
I’ll walk you through this and more as you read on.
designing good business models is an ‘art’ …. the chances are greater if entrepreneurs and managers have a deep understanding of user needs and are good listeners and fast learners.
David Teece – Scholar and Entrepreneur
What A Business Model Isn’t
A business is not a plan nor is it a strategy. A strategy is concerned with long term goals and a plan of action designed to achieve them. A business plan, on the other hand, is focused on how to implement a strategy.
3.1 A Business Model Is Not A Business Strategy
A business is not a plan nor is it a strategy2.
A business model is concerned with how you design your business to:
- meet customers’ needs (offer something that they want to buy).
- generate a profitable revenue stream from sales.
- build a business that has a sustainable competitive advantage – in other words, it can’t easily be replicated.
- provide opportunities for growth.
Essentially, using a business model helps you make better decisions about your business.
For established businesses, it improves how teams make decisions about the future of the business.
For startups, it helps entrepreneurs formulate the best solution to meet customers needs and at the same time be profitable. Whenever I use with entrepreneurs they end up with a much deeper understanding of their options and how they need to put a business together.
A business model isn’t the same thing as a strategy, even though many people think they are similar. A business model is concerned with a firm whereas a strategy takes into account the overall environment the firm operates in.
The business strategy determines which markets a company will operate in, what investments it will make and how it will compete. The goal of the strategy is to develop a sustainable competitive advantage.
Why? Well, you don’t want to carve out a great business only to find one year later another business or several businesses have stolen all your customers, often improving on your initial idea.
Your competitive advantage is always relative, it’s not absolute. What I mean by that is everything changes, constantly shifting, so you need to ensure that you are vigilante and identify how you can adapt your business as others chase and compete for your business.
A business that achieves superior performance relative to other competitors in the same industry or the industry average has a competitive advantage.
A business strategy guides you to choose one, out of many business models, is the best way to compete in your market.
3.2 A Business Model Is Not A Business Plan
There are two different types of plans that often get confused.
- Business plan – the firm’s intention on how to implement its strategy.
- Strategic plan – how a frim will compete given its resources, capabilities and the dynamics of the environment.
A business plan is used at the start of a business. The focus on how a business will implement its strategy. The plan contains clear objectives, tactics and budgets.
A strategic plan is a longer-term plan, usually 3 to five years. A strategic plan prioritizes resources (time, money, people) with the aim of growing the business and net profits. It sets out an overall vision and overarching guide to investors and others.
Strategic planning assesses future options, directions for the business, what markets to invest/divest, what resources are needed…
In contrast, a business model framework is used to systematically assess the viability of a business idea from how it creates value to how it captures value in a market.
Another, often underused, way to harness the power of business modelling is to model competitors and the overall market. To find the dominant business model in the market AND to spot potential threats from new business models e.g. created by startups.
Modelling markets and understanding the dominant logic in a market is a critical part of developing a competitive business model.
As the last point, the other misconceptions are confusing a business model with a market entry strategy, financial plan, brand positioning…these are all components of a broader business strategy.
3.3 A Business Model Is A Framework, Tool And Mental Model
Whatever business model is finally chosen, it needs to be tested. Business models are rarely successful “out of the box” and must be fine-tuned. It is one thing to think of a value proposition, it is quite another to push the product/service into the market and see if customers will actually pay.
In fact, start-ups may need to transform the business model before they enable it to become a profit engine. This is part of the philosophy behind the lean startup.
Of course, mature companies face a different scenario.
4. Why Business Models Are Important?
Business models offer the potential to create a competitive advantage, generate better returns and improve identification and development of innovative opportunities. Those are the hard benefits.
The soft benefits are that top management teams and entrepreneurs develop a shared understanding of a broad set of ideas, explore options and collaboratively make decisions.
Whether you are an entrepreneur or an executive, a business model helps you make better decisions about your business idea. The business model framework helps you to logically put together the pieces of a business, see how they fit together and then make decisions about which business model is the best fit for a strategy and market position.
If you look at how markets and companies have changed over the last two decades you realise that it isn’t the technology that disrupted the markets, it was the business models that new technologies created that caused the disruption.
Gary Fox
4.1 Benefits Of Using Business Modelling
A business model forces you to consider how you make money.
Source: Teece and Linden.
Having worked across lots of different companies I have witnessed the power of using business models to help teams structure and explore business ideas.
Of course, there are different frameworks for business modelling and so part of getting started with the process is to settle on a framework that you feel comfortable with.
- If you are a startup I recommend that you use the Lean Startup Canvas.
- If you are an established business then I recommend the Business Model Canvas.
- If you are a social enterprise then use try using The Flourishing Business Canvas or the Moonfish Circular Business Model.
No matter which one you choose the first step is to gain clarity and understanding of the overall concept, and how the elements of the model contribute to the overall business design.
I’ve listed below some of the benefits of using business models (in case you are sceptical).
4.2 Shared Understanding And Mental Models
A business is a complex system of parts and often people understand some parts better than others.
In large organizations, you can often have different departments, geographically dispersed business units and at any one time a series of different transformation projects running.
All these parts of the business form a business system that is constantly changing. Change one part and it often has a knock-on effect in other parts of the business. Without realising it a business can depart from the original business model but management may still be using an old mental model of how the system works.
As the famous quip suggests, “the map is not the territory.“ 3.
Overtime management teams can lose touch with how these parts create, deliver and capture value. This is where understanding the business model comes in.
A business model simplifies the complexity and provides a structured approach to make decisions 4.
Also, business models help people to understand the bigger picture and share a common mental model of how the business works. 5.
4.2 Opportunities To Explore Innovative Ideas
Often teams will create a portfolio of ideas that then need to validating if they are worth pursuing. Although you may need to do more research, it’s a quick way to weed out bad ideas.
Over time a business will introduce many changes to the way it works. This can be as a result of strategic initiatives and a more general transformation program. However, these changes often fundamentally shift the business model.
Using a business approach top management teams can realign their understanding of the business and their competitive position.
Business models change in the market.
For established firms that means analysing the dominant business model in the market, identifying the beliefs that support and maintain it, then reframing how the elements can be combined to create new value opportunities.
The business model framework offers ways to explore how a business can innovate. Innovative thinking comes from combining different elements of the business model. Another useful way to explore new business models is to take a business model from another industry and see how it could be applied in your market. As an example, what would be the equivalent of an Uber in your market or an Amazon business model?
4.3. Create A Sustainable Advantage
Tomorrow’s competitive advantage of companies will not be based on
The Business Model Navigator – Oliver Gassmann, Karolin Frankenberger, Michaela Csik
products and processes, but on business models
Not every business model will create a competitive advantage nor will it be sustainable. Digital technologies and increasingly agile organisational forms enable firms to copy successful business models. Despite this, a first-mover advantage can lead to fast-growth and domination of a market6.
It’s not bringing in the new ideas that’s so hard; it’s getting rid of the old ones.
John Maynard Keynes
In another section, I’ll cover what makes a successful business model. However, identifying the potential for a sustainable competitive advantage within a business model needs to be one of the main selection criteria.
4.4 Connects The Customer To The Value Proposition
Great businesses start with the customer and work backwards, while weak businesses start with the product. The business model places a huge emphasis on understanding the customer and creating the value proposition. That’s why Osterwalder and Pigneur subsequently went onto produce their book the Value Proposition Canvas.
Startups don’t fail because they lack a product; they fail because they lack customers and a profitable business model.
Steve Blank
Too many startups fail and corporate endeavours get junked. Research shows that one of the main causes is not understanding the customer. The benefit of using a business model is in the focus on the value proposition. From value proposition canvas to customer segments and then to test if there is a viable profit model.
5. Why Some Business Models Are More Successful
Designing a better business model than your competitors is your primary goal.
But, long-term differentiation from competitors is increasingly difficult with products and services.
A value proposition alone isn’t enough. It’s equally difficult to obtain a competitive advantage from a great value proposition alone and more often than not it just gives you the right to compete.
How do you create a moat around your business with a superior business model? Strong business models use one or several Business Model Mechanics to deliver a competitive advantage that’s hard to beat.
The role of a business strategy is to make choices that optimize the long-term value of the business for its shareholders. The business is a tool to help analyze how to
5.1 Protecting Your Business Model
Finding a ‘defensible moat’ then is one of the primary goals when creating and then selecting a business model.
Example 1: Although, it is known for selling hardware e.g. iPhones, iPads and Macs, their IOS software and a large ecosystem of application developers that create a library of apps that people use to customize their phone.
Example 2: The Amazon business model is based on its incredibly large global infrastructure that now represents a huge barrier for others. Furthermore, Amazon used this infrastructure to develop other business models such as AWS.
Assess the health of your current business model and how well it can be defended. How well can you defend your position?
5.2 Switching Costs
What are switching costs?
Switching costs are the costs a customer experiences when changing brands, suppliers, or products. Most people think of switching costs in terms of money, but it can also be time, level of effort as well as psychological barriers.
A switching cost can be significant especially in business to business environments. Changing a supplier runs the risk of disrupting normal operations of a business and often involves deep changes to internal processes. Often, as a result, a business will incur costs associated with training. As an example, a business changing it’s accounting software.
How costly it is for your customers to switch to another company’s offering?
Example 1: Facebook. Many people are heavily invested in Facebook. They have uploaded years of images (often linked to memories) and are connected to their circle of friends (messages and updates). Also, they can receive news and updates from a range of brands and interest groups. These represent high switching barriers. While some people may also use other platforms, many will not completely switch over completely and abandon Facebook.
Example 2: Probably the most famous example, at least until recently, was banks. Most people will move houses more often than they will switch banks. Why? The hassle and difficulty involved previously made it extremely time-consuming and difficult. The reason this is a good example is that now competitors have enabled that switch to be easier, thus they have reduced the moat.
How can you increase your customers’ switching costs OR reduce a competitors moat to steal market share?
5.3 Scalability
How rapidly and easily you can grow your business model without hitting significant barriers?
You are already familiar with how social networks like Facebook scaled their business. As a digital platform, the costs involved in increasing the users were low. This is called marginal costs.
Other platform businesses like Airbnb, Uber, eBay, Alibaba and Google have been able scale and become global businesses.
Digital platforms are among the most scalable business models. This is reflected also in terms of the number of employees relative to their user base and turnover. As an example, prior to being sold to Facebook, WhatsApp had around 400 million users but only employed 60 people.
In contrast, retailers that rely heavily on physical locations employ thousands of people and can’t easily scale because of the competition for prime retail locations.
What parts of your business model are scalable and which parts are not? Can the parts that are scalable be turned into a new solution either for existing customers or used to venture into new markets?
5.4 Earning Vs Spending
Do you generate revenues before you incur the costs of producing and delivering your value proposition to customers?
Typically this type of business model is enabled through customization. Increasingly new technologies have enabled more modular builds of products.
Examples:
- Shoes and clothing – You can now order custom made Levi jeans and customizable Nike shoes.
- Laptop or PC – Dell with their range of custom made, just-in-time, customizable range.
- Vitamins – Persona Health with vitamins made for you.
How can you earn more before spending?
5.5 Recurring Revenues
Recurring revenues trump having to constantly win transactions (one-off sales). This is the principle behind subscription business models and the success of subscription companies like Spotify, Amazon Prime and Netflix.
For Software as a Service (Saas) companies, think Microsoft and Adobe, the market has shifted to subscription model having traditionally been rooted in transactional costs based on new versions fo their software.
Can you turn any part of your business into a subscription model and create a recurring revenue stream?
5.6 Others Do The Work
How much of your business model gets customers or third parties to create value for you (for free)?
Example 1: Many of the social media networks rely on the production and sharing of user-generated content (UGC) to drive their business model. Advertising is the key revenue generator for YouTube, but the user content, sometimes brands, is the driving force behind getting an audience that is then willing to view ads.
Example 2: IKEA changed the furniture market by getting customers to assemble the furniture themselves. All IKEA had to do was to produce the furniture in such a way as to make it easy to assemble. Equally important was their use of their retail space which provided designed areas, e.g. living rooms, dining areas and bedrooms, using their furniture.
How can you get others to do more work for you?
5.7 Seismic Cost Structure Changes
How can you change your cost structure to be substantially different or better than that of your competitors?
Example 1: Up until Whatsapp, telecoms companies relied heavily on making revenue from SMS messages. Not only that but they often placed limits on the number of messages you could send.
Cleverly, Whatsapp realized the opportunity to send messages for free using the phone’s cellular or Wi-Fi connection. Essentially Whatsapp used the existing infrastructure of the carriers to provide their service.
Example 2: Nike trainers were traditionally made from 30-40 pieces which were then stitched together in cheap sweatshops. Not only was this a labour-intensive it also involved lots of different suppliers and logistics. Nike then using ‘micro-level precision engineering’, created their Flyknit shoes. The entire upper part of the shoe is made from a single knitted piece. This reduced production and logistical costs. Not only that, but the shoes were lighter overall and gave performed better for the user.
How can you revolutionize your cost structure rather than just trimming it? Are you aware of potential competitors that might disrupt your business model with a fundamentally different cost structure? What can you turn into a variable cost?
6. The Business Model Canvas Explained
Together the nine sections form a business logic that maps out the decisions about the different parts of the business and how they come together to form the business model.
- Customer Segments
- Value Proposition
- Channels
- Customer Relationships
- Revenue Streams
- Key Activities
- Key Resources
- Key Partnerships
- Cost Structure
Simplifying this further gives us three boxes.
- Feasibility – how do we organise resources to create value?
- Desirability – who are our customers and how does our offer fit to their needs?
- Viability – is this a profitable opportunity?
To understand how to use the business model canvas – see my guide and the step by step instructions.