Your prototype may be ready to present to investors or licensees, but it’s worthless without a solid business model. You need to be able to explain to others what your product does and how it will create value for customers and your company.
Many people use the term “business model,” but few truly understand what it means. As Michael Lewis, the author of The New, New Thing: A Silicon Valley Story, explains, it’s a “term of art” that people recognize but can’t accurately describe.
So, what exactly is a business model, and what are its components? Let’s explore.
What is a Business Model?
A business model is a conceptual framework that outlines how a business operates and achieves its goals. It defines the target market, the products or services offered, the way they are delivered, and how the business generates revenue.
All the policies and procedures a company adopts are part of its business model. According to Peter Drucker, a management expert, a business model should answer the following questions:
- Who is your target customer?
- What value can you create for the customer?
- How can you create this value at a reasonable cost?
In other words, a business model describes how a company creates, delivers, and captures value for both the customer and the business itself.
Components of a Business Model?
An effective business model typically includes four main elements, which can be visualized using a tool called the business model canvas. These elements are the target customers, value proposition, operating model, and revenue model.
More specifically, a business model should answer the following questions:
- Who is the target customer?
- What value does the business provide to its customers?
- How does the business operate?
- How does the business generate revenue?
By answering these questions, a business can create a comprehensive framework that guides its operations and helps it succeed. The business model canvas is a useful tool for organizing and presenting these key components in a clear and concise way.
Who is the Customer?
The customer is the foundation of any business model. It refers to the target market that the company plans to sell its products or services to. Typically, businesses group their customers into different segments based on common needs, characteristics, or behaviors. The business then defines the segment or segments it wants to serve and explains why it has chosen them.
What Value Does the Business Deliver to Customers?
This component of the business model is crucial, as it addresses the key questions of what value the business provides to its customers and how it does so. A value proposition canvas is often used to clarify this aspect of the business model. The canvas helps the business answer the following questions:
- What jobs do customers want to be done?
- What are the pains they experience while doing those jobs?
- What are the gains they expect from doing those jobs?
Once these questions are answered, the business can address another set of questions that relate to the relationship between the business and its customers, such as:
- How does the business get the job done?
- How does the business alleviate the customer’s pain?
- How can the business help the customer achieve their gains?
How Does the Business Operate?
The operating model of the business describes the key activities, partners, resources, channels, and customer relationships that the business utilizes to create and deliver value to its customers. This component of the business model helps the business understand:
- What offerings does the business sell to its customers?
- Who helps the business in delivering value to the customers?
- What resources does the business use to develop and deliver its offerings?
- What channels does the business use to deliver its offerings to its customers?
- What type of relationships does the business maintain with its customers?
How Does the Business Make Money?
Making money is essential for the business to sustain itself. This component of the business model focuses on the financials and explains how the business generates revenue. The revenue model has two components:
- The cost structure includes all the expenses that the business incurs in creating and delivering value to its customers.
- The revenue streams include all the primary and non-primary revenue sources that the business utilizes.
Why Is It Important To Develop A Business Model?
The business model is like a map that guides a business towards success. It helps the founders plan how their business will function and make a profit.
Developing a business model is important because it:
- Clarifies the business idea and the market opportunity it addresses.
- Identifies the target market and the problems the business solves.
- Describes the solution the business offers and how it creates value for customers.
- Outlines how the business gets and retains customers.
- Defines the operating model the business follows.
- Describes the revenue model and the costs incurred to generate revenue.
A clear and effective business model also gives customers a reason to choose the business’s offering over its competitors. For instance, Facebook became popular because it allowed people to connect with others worldwide without charging for the service, while Netflix’s business model provided consistent on-demand content, which was different from the usual TV streaming model.
The 18 Types Of Business Models
There are many different business models, each suited for different types of businesses. Some of the most basic business models include:
A manufacturer takes raw materials and creates finished products, which they may sell directly to customers or through a middleman. Examples include Ford, 3M, and General Electric.
A distributor buys products from manufacturers and resells them to retailers or the public. Examples include auto dealerships.
A retailer buys products from distributors or wholesalers and sells them directly to the public. Examples include Amazon and Tesco.
A franchise can be a manufacturer, distributor, or retailer. Instead of creating a new product, the franchisee uses the parent company’s model and brand while paying royalties. Examples include McDonald’s and Pizza Hut.
This traditional business model involves face-to-face interactions between retailers, wholesalers, and manufacturers in a physical location like an office, shop, or store.
Companies with both online and physical stores allow customers to pick up products from a physical location while placing orders online. This model provides flexibility to customers and is used by many apparel companies.
This model involves offering a basic product at a low cost and charging extra for additional services. Examples include low-cost airlines.
Companies offer basic services for free and charge a premium for extra features. This is a popular model for online companies and is used by Dropbox and YouTube.
This model is useful when customer acquisition costs are high. It lets companies keep customers through long-term contracts and recurring revenues, as seen with Netflix and Dollar Shave Club.
This model involves selling services from different providers under one brand, earning money as commissions. Examples include Uber and Airbnb.
12. Online marketplace:
Marketplaces aggregate different sellers onto one platform where they compete to offer the same product at competitive prices. Examples include Amazon and Alibaba.
This model involves providing information for free while accompanying it with paid advertisements from sponsors, as seen on YouTube and Forbes.
14. Data licensing / data selling:
An agency specializes in handling non-core business activities like advertising, digital marketing, PR, and ORM, partnering with other companies to outsource these tasks. Examples include Ogilvy & Mathers and Dentsu Aegis Network.
16. Affiliate marketing:
Affiliate marketing is commission-based model involves promoting a partner’s product to followers and users. The affiliate earns a commission for every sale referred. Examples include Lifewire.com.
This e-commerce model involves owning no product or inventory but operating a store. Partner sellers deliver products directly to customers when orders are received.
18. Network marketing:
Network marketing business model involves a pyramid-structured network of people who sell a company’s products, with participants being remunerated for making sales.
It’s important to note that many companies don’t strictly adhere to just one business model, but instead, adopt a blend of several. For instance, you could opt to be a Bricks-and-Clicks Low Touch Retailer or even a High Touch Subscription-Based Manufacturer. Your choice of business model ultimately hinges on your business requirements and the value you aim to deliver to your stakeholders. Moving forward, let’s explore how you can create the ideal business model for your startup, thus increasing your chances of success. If you haven’t understood yet, you can watch this video explaining the business model.