Your prototype might be ready for presentation to investors or licensees, but it is worth nothing if you do not have a business model in place. How will you explain to anyone what your product does or intends to do and how it will create value for customers and the company?
You need a business model for that.
It is a term people frequently use, but most of them don’t truly understand what it means. Michael Lewis, the author of The New, New Thing: A Silicon Valley Story, says that a business model is a “term of art”. Most people know it when they see it but cannot accurately describe it.
So, what exactly is a business model, and what are its components?
Let’s find out.
What Is A Business Model?
A business model is a conceptual structure that supports the viability of the business and explains who the business serves, what it offers, how it offers it, and how it achieves its goals.
All the business processes and policies that a company adopts and follows are part of the business model.
According to management coach Peter Drucker:
A business model is supposed to answer who your customer is, what value you can create/add for the customer and how you can do that at reasonable costs.
Thus, a business model is a description of how a company creates, delivers, and captures value for the customer as well as itself.
What Are The Components of A Business Model?
An ideal business model usually conveys four key aspects of the business, which are presented using a specialised tool called business model canvas. These key components are customers, value proposition, operating model, and revenue model.
Precisely, a business model answers the following key questions –
- Who is the customer?
- What value does the business deliver to the customers?
- How does the business operate?
- How does the business make money?
Who Is The Customer?
The customer forms the heart of a business model. It answers who the company plans to sell its offerings to. A business usually groups customers into different segments with certain homogeneous needs, characteristics, or behaviour. It then defines one or more customer segments that it serves or wants to serve, followed by an answer to why it plans to serve this segment.
What Value Does The Business Deliver To The Customers?
This is the most important component of a business model that answers several key customer and business value-related questions. It is often usually presented using a value proposition canvas.
- What are the jobs the customer wants to be done?
- What are their pains in doing the job?
- What do they gain by doing the job?
Once these questions are answered, the business answers another set of questions that relates business to the customers:
- How does the business get the job done?
- How does the business relieve the customer’s pain?
- How can the business help the customer get the gains?
How Does The Business Operate?
It’s the operating model of the business that elaborates:
- Key Activities: What all offerings does the business sell to the customers?
- Key Partners: Who helps the business in delivering value to the customers?
- Key Resources: What all resources do the business uses to develop and deliver its offerings?
- Key Channels: What channels does the business use to deliver its offerings to the customers?
- Customer Relationships: What type of relationships does the business maintain with its customers?
How Does The Business Make Money?
Making money is important for the business to sustain itself. This component of the business model focuses on elaborating on the financials and how the business makes money.
It’s called the revenue model of the business and has two components:
- The cost structure includes all the expenses that the business incurs in creating and delivering value to the customers.
- The revenue streams include all the primary and non-primary revenue streams that the business utilises.
Why Is It Important To Develop A Business Model?
The business model acts as the blueprint of the business and a roadmap for its success (or failure). This tool helps the founders decide how their business will work and make money.
It is the only documentation that makes clear –
- The business concept – the market opportunity the business capitalises on.
- The target market the business caters to.
- The problems the business intends to solve.
- The solution the business offers and how it creates customer value.
- How the business gets its customers.
- The operating model the business follows.
- How the business makes money, and what are the costs incurred to get the same.
Moreover, the business model gives a reason for the customers to choose the offering over others in the market. People chose Facebook because it helped them connect and chat with other people around the world (operating model), and it didn’t even charge for it (revenue model). Netflix’s business model was preferred over others as it provided value in the form of consistent on-demand content instead of the usual TV streaming business model.
The 30 Types Of Business Models
There are different types of business models meant for different businesses. Some of the basic types of business models are:
A manufacturer makes finished products from raw materials. It may sell directly to the customers or sell it to a middleman i.e another business that sells it finally to the customer. Examples – Ford, 3M, General Electric.
A distributor buys products from manufacturers and resells them to retailers or the public. Examples – Auto Dealerships.
A franchise can be a manufacturer, distributor or retailer. Instead of creating a new product, the franchisee uses the parent business’s model and brand while paying royalties to it. Examples are McDonald’s and Pizza Hut.
Brick-and-mortar is a traditional business model where retailers, wholesalers, and manufacturers deal with customers face-to-face in an office, a shop, or a store that the business owns or rents.
The ecommerce business model is an upgradation of the traditional brick-and-mortar business model. It focuses on selling products by creating a web store on the internet.
A company that has both an online and offline presence allows customers to pick up products from the physical stores while they can place the order online. This model gives flexibility to the business since it is present online for customers who live in areas where they do not have brick-and-mortar stores. Examples – Almost all apparel companies nowadays.
In this model, the basic product provided to the customers is very cost-sensitive and hence priced as low as possible. For every other service that comes with it, a certain amount is charged. Examples – All low-cost air carriers.
Freemium is one of the most common business models on the Internet. Companies offer basic services to customers for free while charging a certain premium for extra add-ons. So there will be multiple plans with various benefits for different customers. Generally, the basic service comes with certain restrictions or limitations, such as in-app advertisements, storage restrictions etc., which the premium plans shall not have. For example, the basic version of Dropbox comes with 2 GB of storage. If you want to increase that limit, you can move to the Pro plan and pay a monthly premium of $9.99 a month. Some online image editors allow you to edit only a certain number of images in the free basic plan while an unlimited number of images is in the paid plan.
Youtube’s free plan comes with ads, while the premium plan has no ad interruption and other benefits. This model is one of the most adopted models for online companies because it is not only a great marketing tool but also a cost-effective way to scale up and attract new users.
If customer acquisition costs are high, this business model might be the most suitable option. The subscription business model lets you keep customers over a long-term contract and get recurring revenues from them through repeat purchases. Examples – Netflix, Dollar Shave Club.
The aggregator business model is a recently developed model where the company has various service providers of a niche and sells its services under its own brand. The money is earned as commissions. Examples – Uber, Airbnb, Oyo.
Online marketplaces aggregate different sellers into one platform who compete to provide the same product/service at competitive prices. The marketplace builds its brand over different factors like trust, free and/or on-time home delivery, quality sellers, etc. and earns a commission on every sale carried on its platform. Examples are Amazon and Alibaba.
Advertisement business models are evolving even more with the rise of the demand for free products and services on the internet. Just like the earlier times, these business models are popular with media publishers like Youtube, Forbes, etc., where the information is provided for free but is accompanied by advertisements that are paid for by identified sponsors.
Data Licencing / Data Selling
With the advent of the internet, there has been an increase in the amount of data generated from users’ activities over the internet. This has led to the advent of a new business model – the data licencing business model. Many companies like Twitter and Onesignal sell or licence the data of their users to third parties who then use the same for analysis, advertising, and other purposes.
An agency can be considered a partner company that specialises in handling non-core business activities like advertising, digital marketing, PR, ORM, etc. This company partners with several other companies that outsource their non-core tasks to them and is responsible for maintaining privacy and efficiency in their work. Examples of such agencies are Ogilvy & Mathers, Dentsu Aegis Network, etc.
The affiliate marketing business model is a commission-based model where the affiliate builds its business around promoting a partner’s product and directs all its efforts to convince its followers and users to buy the same. In return, the affiliate gets a commission for every sale referred. An example of a business operating on an affiliate marketing business model is lifewire.com.
Dropshipping is a type of e-commerce business model where the business owns no product or inventory but just a store. The actual product is sold by partner sellers who receive the order as soon as the store receives an order from the ultimate customer. These partner sellers then deliver the products directly to the customer.
Network marketing or multi-level marketing involves a pyramid-structured network of people who sell a company’s products. The model runs on a commission basis where the participants are remunerated when –
- They make a sale of the company’s product.
- Their recruits make a sale of the product.
The network marketing business model works on direct marketing and direct selling philosophy where there are no retail shops, but the offerings are marketed to the target market directly by the participants. The market is tapped by making more and more people part of the pyramid structure, where they make money by selling more goods and getting more people on board.
The crowdsourcing business model involves the users contributing to the value provided. This business model is often combined with other business and revenue models to create an ultimate solution for the user and to earn money. Examples of businesses using the crowdsourcing business model are Wikipedia, reCAPTCHA, Duolingo, etc.
Peer 2 Peer Catalyst/Platform
A P2P economy is a decentralized internet-based economy where two parties interact directly with each other to buy or sell goods or to conduct a transaction without the intervention of any third party. A P2P catalyst is a platform where these users meet. Examples of P2P platforms are Craigslist, OLX, Airbnb etc.
The Blockchain is an immutable, decentralised digital ledger. It is a digital database that no one owns, but anyone can contribute to. Many businesses are taking this decentralised route to develop their business models. Models based on blockchain are not owned or monitored by a single entity. Rather, they work on peer-to-peer interactions and record everything on a digital decentralized ledger.
SAAS, IAAS, PAAS
Many companies have started offering their software, platform, and infrastructure as a service. The ‘as a service’ business model works on the principle of pay-as-you-go, where the customer pays for his usage of such software, platform, and infrastructure; he pays for what and how many features he has used and not for what he hasn’t.
The high-touch model is one that requires lots of human interaction. The relationship between the salesperson and the customer has a huge impact on the overall revenues of the company. Companies with this business model operate on trust and credibility. Examples are hair salons and consulting firms.
The opposite of the high-touch model, the low-touch model requires minimal human assistance or intervention in selling a product or service. Since, as a company, you do not have to maintain a huge sales force, your costs decrease, though such companies also focus on improving technology to reduce human intervention further while making the customer experience better at the same time. Examples – Ikea, SurveyMonkey.
Mostly used for unique items that are not frequently traded and that don’t have a well-established market value, like collectables, antiques, real estate, and even businesses.
This business model involves the listing of an offering by the seller and the buyers making repeated bids to buy that offering while fully aware of other bids by other buyers. The offering is sold to the highest buyer, with the auction broker charging a listing fee and/or commission based on the transaction value.
eBay is one such auction platform.
A reverse auction is an auction where the roles of a buyer and seller are exchanged, i.e. sellers bid prices instead of buyers.
The reverse-auction-based business model is often used when there are several sellers selling a similar offering to a single buyer. These sellers lower their prices with every bid; generally, the lowest bidder wins the auction. However, there are cases when the bidder with a price higher than the lowest bid wins the auction as the buyer likes his offer (offering with add-ons)
A platform that lets sellers bid for government contracts is an example of a reverse auction-based business model.
Razor And Blades
Razor and blade model is used by companies that deal in complementary or companion products like razors and blades.
It involves selling the high-margin root product at a low price to increase the volume of sales of the complementary or related low-margin product.
By using this model, businesses create a stream of recurring income over the life of the root product.
Companies dealing in razors, mosquito vaporizers, and other refillable products employ this business model. The game industry also makes use of this model by providing the gaming console at a very economical price and making good profits with the sale of games.
Reverse Razor And Blades
A business employing a reverse razor and blades model offers the low-margin item at a very less price or below the cost to encourage the sale of the high-margin product.
Amazon employs this business model to sell its Kindle e-reader. It provides Kindle ebooks at a price lower than their actual cost to make people consider Kindle as a one-time investment to enjoy low-cost books throughout its life.
An on-demand model is where a customer’s demand is fulfilled by delivering goods and services on demand (usually immediately).
The use of the Internet and mobile phones drives this business model. It works like this –
- The customer order for products on services through a web app.
- The company’s employee or a demand-fulfilling partner receives the request.
- The employee or a partner fulfils the demand by delivering the ordered product or service either immediately or in the time promised.
Uber, Instacart, and Postmates are some examples of an on-demand business models.
Driven by the network effect, this business model involves granting access to a community or a network in return for a membership fee.
Glassdoor is a good example of such a user community.
Of course, most companies do not operate on any one of these business models but rather on a combination of some. You can be a Bricks-and-clicks Low Touch Retailer or a High Touch Subscription-Based Manufacturer. What business model you choose depends on your business needs and what value you want to create for your stakeholders. Next, we will see how to develop the perfect business model for your startup so that the chances of your success are amplified.
The Startup Process
We know how important your dream business is to you. Therefore, we’ve come up with an all-in-one guide: The Startup Process to help you turn your vision into reality.
A startup consultant, digital marketer, traveller, and philomath. Aashish has worked with over 20 startups and successfully helped them ideate, raise money, and succeed. When not working, he can be found hiking, camping, and stargazing.