Business Model

Definition of Business Model

A Business Model describes an architecture for how a firm creates and delivers value to customers and the mechanisms employed to capture a share of that value (Teece, 2018).

In its simplest form, a Business Model is your profit formula. You use it to acquire customers, service them, and make money.

A Business Model is a design for the successful operation of a business, identifying revenue sources, customer base, products, and financing details.

A Company's Business Model sets forth the logic of how its strategy will create value for customers while at the same time generating revenues sufficient to cover costs and realize a profit.

The business model question is often answered with information on what products a company sells and at what price level to which customers. At the management level, this response is often manifested through budget scenarios or a number-heavy business planning, ie business models are reflected in this sense, complex calculations to price, cost, and sales scenarios

In theory and practice, the term business model is used for a broad range of informal and formal descriptions to represent core aspects of a business, including purpose, business process, target customers, offerings, strategies, infrastructure, organizational structures, sourcing, trading practices, and operational processes and policies including culture. The literature has provided very diverse interpretations and definitions of a business model. A systematic review and analysis of manager responses to a survey define business models as the design of organizational structures to enact a commercial opportunity. Further extensions to this design logic emphasize using narrative or coherence in business model descriptions as mechanisms by which entrepreneurs create extraordinarily successful growth firms.

Elements of a Business Model Design (Figure 1.)

A business model articulates the logic and provides data and other evidence demonstrating how a business creates and delivers value to customers. It also outlines the architecture of revenues, costs, and profits associated with the business enterprise delivering that value. The different elements that need to be determined in business model design are listed in Figure 1. The issues related to good business model design are all interrelated, and lie at the core of the fundamental question asked by business strategists, ie, how does one build a sustainable competitive advantage and turn a super normal profit? In short, a business model defines how the enterprise creates and delivers value to customers, and then converts payments received to profits. To profit from innovation, business pioneers need to excel not only at product innovation but also at business model design, understanding business design options as well as customer needs and technological trajectories. Developing a successful business model is insufficient to assure competitive advantage as imitation is often easy: a differentiated (and hard to imitate) yet effective and efficient business model is more likely to yield profits. Business model innovation can itself be a pathway to competitive advantage if the model is sufficiently differentiated and hard to replicate for incumbents and new entrants alike. In essence, a business model embodies nothing less than the organizational and financial ‘architecture’ of a business. It is not a spreadsheet or computer model, although a business model might well become embedded in a business plan and in income statements and cash flow projections. But, clearly, the notion refers in the first instance to a conceptual, rather than a financial, model of a business. It makes implicit assumptions about customers, the behavior of revenues and costs, the changing nature of user needs, and likely competitor responses. It outlines the business logic required to earn a profit (if one is available to be earned) and, once adopted, defines the way the enterprise goes to market. But it is not quite the same as a strategy.

Figure 1. source: David J. Teece

The Business Model Wheel™ (Figure 2.)

There are three aspects to all Business Models which are then structured into eight areas:

1. What is the Offering?
   • Market Attractiveness
   • Unique Value Proposition
2. How will you Monetize the Offering?
   • Profit Model
   • Sales Performance Model
3. How will you sustain it?
   • Ongoing Competitive Advantage
   • Innovation Factor
   • Avoidance of Pitfalls
   • Graceful Exit

Figure 2. source: Business Model Institute

Business Model Innovation (Figure 3.)

Business Model Innovation is becoming a hot topic these days as business leaders increasingly recognize that Disruptive Innovation requires not only innovative products but also fundamentally new business models. The key to Business Model Innovation is to think holistically about the entire business, not just new product development. One may use a three-dimensional framework for thinking about business models:

• Create Value: A value proposition that effectively differentiates your offering and fulfills a want/need for an under-served segment of consumers
• Deliver Value: Determining the key activities and resources your organization will need to fulfill the value proposition. Activities and resources include elements like physical resources, human resources, supply chain management, partnerships, and technology
• Capture Value: Value can be captured in a variety of ways, including one-time payment, subscription, or through advertising.

Figure 3. source: Creative Realities

Business Model Mapping

A Business Model Mapping method can be used for plotting how these elements come together. The point is that innovation can occur anywhere in the operation. Business model innovation is about looking at the entire enterprise and developing a structure that maximizes value for all stakeholders. The best business models, such as iTunes, "expand the pie" and increase value for the entire ecosystem.

The Advantages of a Business Model

• Competitive Advantage: A significant advantage of a solid business model is that it can give you a competitive edge over other companies in your industry. Implementing a unique business model can give your company a unique reputation in the marketplace, creating buzz among consumers and encouraging first-time purchases. Consider the first pizza shop to offer online ordering for customers. This was an alteration of an existing business model that facilitated a new means of placing an order and making a payment while directly increasing employee productivity by cutting down phone time. Whoever first introduced this business model likely experienced a significant boost in orders and a reduction in expenses.
• Plan For Growth: A company can survive simply by breaking even each month, but it must then rely on debt financing for expansion. A solid business model that consistently brings profit into the organization can help to build a cash reserve that can be used for investment in new real property, equipment, or research and development efforts.
• Financial Sustainability: The largest advantage of a robust and proven business model is the contribution it makes to organizational sustainability and the ability to weather economic storms or shifting market conditions. A staggering number of businesses close their doors each year solely due to poor financial management. A business model forces an entrepreneur to keep abreast of exactly how much profit is being made each month.
• Lenders And Investors: Lenders and investors are well acquainted with small business failure rates. No matter how novel or market-oriented your products and services are, lenders and investors want to know that you have a plan for profitability. Being able to elaborate on and answer questions about your business model and profit expectations can give you a large advantage over competitors when seeking new financing.

Why Business Models Fail?

There are a lot of reasons why business models fail. Understanding them can help us better manage risks. Here are four major mistakes to be on the lookout for to avoid failing indefinitely.

• Solving an Irrelevant Customer Job: Your business model will fail if it is built around a value proposition that solves a customer job that customers don't care about, or that customers don't care about enough. In the start-up world, this is called a failure to achieve product-market fit. No business model can survive long-term without product-market fit, no matter how great it looked in the business plan. Trivial, right? So why does it happen over and over again? This type of mistake is often driven by an overly strong focus on products, services, technologies, and features. What you want to focus on first, before thinking about features, is figuring out which jobs customers are trying to get done, which pains bother them most, and which gains they are trying to achieve. Once you understand what matters most to customers, make sure your products and services sufficiently alleviate pains or create substantial gains. Otherwise, you'll fail even if you target the right jobs, pains, and gains.
• A Flawed Business Model: Solving relevant customer jobs and finding product-market fit is just one of many important factors that make up a business. Great technologies, products, and services must also have the right business models to support and sustain them. You will fail even with value propositions that customers want or technologies that customers crave if your business model is flawed (e.g. few people know that Kodak, which filed for bankruptcy in 2012, helped invent the digital camera that crushed its business model). The most obvious flaw is when a business model's value propositions generate more costs than revenues from customers. The business will inevitably disappear, even with the most successful value propositions. But it still happens all the time! You might pick the wrong revenue model or pricing structure or underestimate the costs you incur from the activities, resources, and partnerships required to create and deliver your value proposition. Further, your business model is flawed if you fail to establish the proper channels to reach and deliver value to your customers. Does it matter how brilliant your value proposition is if your potential customers don't know about it or can't find it? Your business model might also be flawed if you fail to establish customer relationships that allow you to successfully retain and grow your customer base sustainably (e.g. think Zynga or King and Candy Crush). Finally, your business model will fail if you focus on the wrong activities or lack access to the right key partners and resources to reliably create, deliver, and capture value long-term. To be successful, design a business model that works not only for your customers but also for your company.
• Neglecting External Threats in the Business Model Environment: You can still fail even if you are solving relevant customer jobs and have a sound business model design. This third source of failure stems from external threats. The most obvious threats are your potential competitors. You may never even acquire customers if your competition's business model locks in customers and prevents them from switching to you (e.g. think competing against Apple products). Also, your customer's jobs, pains, and desired gains can change and evolve over time, especially as new and improved competitive offerings and substitutes become available. Changes in the macro environment as well as shifting technological, regulatory, societal, cultural, and socioeconomic trends can have big impacts on the viability of your business model, both in the near and distant future. The most successful companies constantly scan their business model environment to stay abreast of impending threats to their business models.
• Poor Execution: With the previous fundamentals in place, your business model can still fail if you execute poorly. If your company's resources (physical, human, and capital) are not properly aligned around the most critical elements of the business model, it's liable to fail. Additionally, most companies measure and monitor a lot of things, but rarely do they use the business model as a starting point to define the critical success factors to follow. By regularly measuring and monitoring the key success factors of your business model, you can ensure proper alignment of resources around the model. Good companies execute flawlessly but the best companies seek to improve and refine their business models relentlessly while proactively looking for ways to reinvent them entirely (e.g. Amazon and Hilti).

Uncertain Business Models

A trend in recent years has however been the growth of companies (often Web 2.0 ones) with uncertain business models. Take Twitter, for example: “Twitter has become an influencer in the way information is shared around the world. But while its immediacy, transparency, and simplicity offer answers about all things both newsworthy and mundane, one big question about Twitter has gone virtually unanswered: how it plans to turn a profit.” Source: CNN article (July 9, 2010) Of course, the big challenge for the likes of Twitter, Facebook, and other social media sites is that attempts to monetize come at a number of costs, often the privacy of the user and their ability to use the service without interruptions from third-party advertisers. Monetizing a free service invariably degrades the experience for the customer and hence companies need to walk a fine line as Facebook found to its cost in recent months.

Business Model vs. Business Plan

• The business model is the mechanism through which the company generates its profit while the business plan is a document presenting the company's strategy and expected financial performance for the years to come.
• The business model is at the center of the business plan.
• The business model describes how the company is positioned within its industry's value chain, and how it organizes its relations with its suppliers, clients, and partners in order to generate profits. The business plan translates this positioning into a series of strategic actions and quantifies its financial impact.

Business Model vs. Business Strategy

The mainstream business press often conflates business strategies with business models. For example, a company like Kickstarter or Amazon will be held up as a new economy company employing a unique business model, when both companies have simply updated existing business models for the digital era. Where companies like Kickstarter and Amazon beat the competition is in their strategies, not their business models. Business models describe how a company is structured and its methods for maximizing revenues and profits. The business model is independent of competitors and the current state of the market, which is where strategy comes in. The business strategy describes how the company will engage competitors, identify and segment customers, and respond to the actual market environment. A business model is not the same thing as a business strategy, and a business strategy should not be confused with a business model. Strategies are very specific to how businesses interact with competitors in the marketplace and win customers, while business models address the fundamental structure of the business. Naturally, both are tightly intertwined, and a successful company must seek the ideal business model and market strategy in order to be successful. But if you find that you are losing in the marketplace and your strategy isn't working, don't assume you have to throw out your entire business model.

Commom Frameworks, Methods, and Models for Business Model Innovation and Strategy

Business model innovation and strategy involve various frameworks, models, and methods to help businesses understand, analyze, and create value. These tools are crucial for identifying competitive advantages, addressing customer needs, and achieving sustainable growth. Below are some of the key frameworks, models, and methods used in business model development:

• Business Model Canvas (BMC): Developed by Alexander Osterwalder and Yves Pigneur, the BMC provides a visual chart with elements describing a firm's value proposition, infrastructure, customers, and finances. It helps businesses to align their activities by straightforwardly illustrating potential trade-offs.
• Value Proposition Canvas (VPC): A complement to the BMC, the VPC focuses on understanding customer needs and designing a value proposition that addresses those needs. It is divided into the customer profile and the value map, helping businesses create products and services that customers want.
• SWOT Analysis: A strategic planning tool used to identify the Strengths, Weaknesses, Opportunities, and Threats related to business competition or project planning. It helps understand internal and external factors that could impact the business.
• Porter’s Five Forces: Developed by Michael E. Porter, this model analyzes the industry structure and the level of competition in an industry. The five forces are competitive rivalry, supplier power, buyer power, threat of substitution, and threat of new entry. This analysis helps in understanding the competitive intensity and attractiveness of a market.
• Blue Ocean Strategy: Introduced by W. Chan Kim and Renée Mauborgne, the Blue Ocean Strategy suggests that companies can succeed not by battling competitors but rather by creating ″blue oceans″ of uncontested market space. It emphasizes creating new demand and making the competition irrelevant.
• Lean Startup Methodology: Developed by Eric Ries, it focuses on creating and managing startups more efficiently by building a minimum viable product (MVP), measuring its success in the market, and learning from the experience to iterate or pivot quickly.
• PESTEL Analysis: This tool examines the Political, Economic, Social, Technological, Environmental, and Legal factors that could impact an organization. It helps in understanding the macro-environmental factors that can influence strategic decision-making.
• Ansoff Matrix: Developed by Igor Ansoff, this matrix helps businesses decide their product and market growth strategy by analyzing existing and new products in existing and new markets. It includes strategies like market penetration, market development, product development, and diversification.
• Value Chain Analysis: A method by Michael Porter that breaks down a company’s activities to examine how each contributes to the value created for customers. It helps businesses identify competitive advantages in those activities and find ways to increase efficiency or differentiation.
• Jobs to be Done (JTBD) Framework: A concept that focuses on understanding the ″jobs″ customers are trying to get done. It helps in identifying customer needs and motivations, leading to the development of products and services that precisely address those needs.

These frameworks, models, and methods are not mutually exclusive and are often used in combination to provide a comprehensive view of a business's strategic landscape. They serve as tools to analyze, design, and implement effective business models that can adapt and thrive in changing market conditions.

See Also

• Value Proposition: The unique value a company offers to its customers. It's a critical aspect of the business model that defines why customers should choose a company's product or service over competitors.
• Revenue Streams: The various sources a business earns money from its value proposition. This includes direct sales, subscription fees, advertising revenues, licensing, and any other means the business generates income.
• Cost Structure: The composition of a company's fixed and variable costs in operating its business model. Understanding and managing the cost structure is vital for pricing strategies and profitability.
• Customer Segments: The different groups of people or organizations a business aims to reach and serve. Each segment has specific needs, behaviors, and attributes that require tailored value propositions and channels.
• Channels: How a company delivers its value proposition to customer segments. This can include physical distribution channels, online platforms, retail locations, and more.
• Customer Relationships: The types of relationships a company establishes with specific customer segments. This can range from personal assistance to automated services, influencing customer satisfaction and loyalty.
• Key Activities: The most important actions a company must take to operate successfully according to its business model. This can include production, problem-solving, and platform/network management.
• Key Resources: The assets required to offer and deliver the previously mentioned elements (value proposition, channels, customer relationships, revenue streams). Resources can be physical, financial, intellectual, or human.
• Key Partnerships: The network of suppliers and partners that make the business model work. This includes alliances with other businesses, government agencies, and non-profit organizations that help reduce risk and build value.
• Market Fit: The degree to which a company's value proposition satisfies the needs and preferences of its target customer segments. Achieving a good market fit is crucial for the success and sustainability of a business model.
• Operating Model
• 3C's Model

Further Reading

• What Is a Business Model? - History of
• Do You Really Understand What Your Business Model Is?
• Examples of Well-Known Business Models
• 6 Great Business Models to Consider for a Startup
• The 7 Elements of a Strong Business Model
• Building An Innovative Business Model Incubator