A business model is something every entrepreneur gets asked for, lots of words are written about, but there seems to be a dearth of accessible help on figuring out what to do about it.
This guide is intended to help you understand what a business model is, what a good one looks like (and how to spot a bad one), how to create one, and how to make use of one.
“All it really meant was how you planned to make money.”
A business model is a summary of how a business will work that highlights the essential aspects: desirability, feasibility, and viability.
Is this a desirable business to be in? Do you know who your customers are? What problem do you solve for them? Why they will buy your solution? Why will they pay what you want? Can you reach those customers? Can you keep them? Many businesses founder because they misjudge the needs of customers or their ability and willingness to pay so it's important to get this right.
Is this a feasible business? You have imagined something people want, but do you understand how to do what you need to do, do you have the right resources and partners available to help you? Can you scale? If your ideas are not practical enough to be implemented the business will ultimately fail no matter how good it sounds.
Is this a viable business to own? This is to say that you can demonstrate that people want what you do and that you can deliver it. But can you make money by doing it? This is about your profit model and a lot of companies inadvertently do this wrong and leave a lot of money on the table, sacrificing their viability.
The purpose of creating a business model is to reveal the assumptions you have made and make it easier to explore alternative variations of a business to find which ones may work best.
Once you have a business model you should be able to answer questions like:
• Why will different kinds of customer come to us?
• How will we reach them?
• What kind of relationship will we have with them?
• How will we serve them?
• What do they find valuable?
• How do we help them make progress in their lives?
• What will they pay us?
• How often will they pay us?
• Do we have what we need?
• Who will help us?
By exploring the answers to these questions we can reassure, and other potentially interested parties (such as investors), that we are building a business that can be successful at scale.
“A plan for the successful operation of a business, identifying sources of revenue, the intended customer base, and details of financing”
Let's assume that you don't have one, what would you do instead?
You wouldn't have a guiding definition of who your customers are, so you'd do a lot of guessing and probably waste a lot of time trying to sell to the wrong people.
You know what that looks like. That's where you explain what you do and they say "not interested" or, worse, they say "that's interesting" but mean 'not interested'. That wastes your time, trapping you in a conversation that can go nowhere when you could have been talking to someone else more promising.
What we're talking about is product/market fit.
You wouldn't understand the best way to extract your part of the value that the customer is receiving.
This means that you are likely to fall back on the cost-plus pricing model that is usually the least effective model around (unless you are in a highly commoditized market where you may be forced into it).
You wouldn't know the channels that you will use to reach your market.
So you will probably be looking for people in all the wrong places, or maybe not using a channel at all and trying to find all of your customers yourself. That may work in the short term but, eventually, you are going to need channels.
If you don't identify the right channels you cannot hope to have product/channel fit.
Now you may think to yourself that you do know a lot of these things, or think you do. But do you have them written down? Are they open to challenge?
The central issue of the business model is the assumptions that underpin it. Often some of those assumptions, and they can be key assumptions, will be either wholly or partly wrong. This can be very expensive.
A business model is how you explain your assumptions to others in a way that can be tested by others to show you where you have made a mistake.
“Luck is not a business model.”
Let's compare a 'classic' and 'new' business model and see how they work.
Beginning in the late '80s computer with home computers software started to be sold as a separate product. When you bought software it came in a cardboard box and it was either shipped to you mail order or you bought it off a store shelf like laundry detergent.
When a new version of the software appeared you went back to the store and bought a new copy. This often created problems with upgrades. Leading to companies having to have two boxes.
This was a pretty easy business model to understand and is unsurprising since many of the people selling computer software back then had come from selling other kinds of products, like electronics where there was a physical box item.
However, software is more like a digital photograph or audio file than a circuit board. All those cardboard boxes, stocking fees, inventory costs and delivery costs were overheads to a business with a fundamentally digital product.
When the internet began to enable the delivery of digital media it was obvious that software would follow suit. But the online model was, other than the lack of a cardboard box, pretty similar to the offline model.
Eventually, software producers caught on to the idea that instead of selling you a license to use a piece of software they could rent you the software instead. Hence "Software as a Service" (because it sounds better than Software Rental).
But why would you want to do this?
Two big problems for many companies are (a) uneven cash flow and (b) constantly having to sell.
Where cashflow is uneven it can jeopardise the stability of the business, especially in younger businesses. You may be expecting money, but you can't spend that. Subscription models give greater predictability of revenue.
In a product based model you have to repeatedly sell although different kinds of product have different cycles. You might only buy a car once every 5 or 10 years, you probably buy laundry detergent every couple of weeks. And this creates a problem. If the customer has a choice of what to buy, they might not buy your product again but one of your competitors’!
Introducing a subscription model inverts the decision mechanism. Instead of the customer repeatedly "choosing to buy" they default to buying and have to "choose to cancel". This makes the work of competitors to "convert" customers much higher.
So a subscription-based model, done right, provides greater predictability and stability of revenue which is a great thing for a business to have.
“A startup is a temporary organization designed to search for a repeatable and scalable business model.”
A good business model identifies a clear and present customer need that you can address. It identifies the scope of the market and your ability to reach it. It outlines activities to exploit the opportunity that are scalable and demonstrates how you make a good amount of revenue this way.
A good business model is any model that gives you what you want. But this is not a binary system of "good model"/"bad model" since all models exist on a scale. So what kind of models are better?
This is going to be very situational in terms of what you want the business to deliver for you. If you want to be a unicorn (a business with a $1 trillion + valuation) there are very few business models that are "good". If your aims are more modest more kinds of models can work.
A very popular kind of business model right now is the SaaS model which is to say "Software as a service" or, as it's often purchased, "Software as a subscription". As it has become easier to deliver software via the web and setup subscription based payments this model has gained prominence.
This is for two reasons
Subscriptions tend to yield higher LTV.
If you think about toothpaste as an example. About every 3-4 weeks you go to the supermarket and buy toothpaste. Chances are you buy the toothpaste you bought last time but maybe you don't remember which one that was, or maybe a different brand is on offer that week. You are making buying decisions on a regular basis.
If someone offered you a "toothpaste subscription" you only have to make the buying decision once. As long as the product continues to satisfy you they don't have to keep selling you over and over. This makes for a nice steady revenue stream for them.
And it gets better since they can raise the price of the subscription and, done carefully, you keep on paying.
A good business model is something that helps you understand how to operate and how to explain what you do to people who are going to need to know. A good example would be an investor.
A good business model clarifies what you are doing to
find dangerous assumptions and de-risk them
expose key parts of what you are doing to scrutiny
apply innovative thinking to how you generate value
“A set of assumptions about what a business will and won’t do.”
A desirable business model is one where we can imagine customers that are easy to access and who will find our offering appealing, where we can deliver the offering easily, and where we can make a good profit on doing so.
Typically, there's no one — right — business model but rather many that could work and you are searching a range of related models looking for those that are most advantageous.
The process of looking for a good business model is usually iterative around key assumptions, for example
• Which is the best customer to target?
• What is the easiest way to build a product?
• What is the best profit model?
In choosing a business model you are often looking for an advantage over competitors. Typically this is about reducing the cost of your offering (to enhance profitability or undercut competitors) or improving the value of your offering (to make it more attractive and to command a higher price).
A good business model incorporates some areas where you both increase the value but, at the same time, decrease the cost. That means you are looking for areas where you define value but make it hard for potential competitors to compete with you.
There is a range of tools that can help you in this process such as the Strategyzer Business Model Canvas and Value Proposition Design canvas, the Precoil Assumption Mapping Worksheet, and the COMPASS Customer Canvas.
Deciding whether you have a good business model is, ultimately, a matter of judgement. You are talking about what you will do in the future so partly it's about projecting what you've done so far, and partly it's about capturing opportunities to do better.
“a business model is a framework by which you extract from your customers some proportion of the value your product creates for them.”
If you can identify a business model then it's certainly possible to copy it, especially if it doesn't depend upon access to restricted resources or intellectual property.
The real question is, when is it a good move to copy an existing business model?
Historically a good time to copy a business model is when it's in a fairly new market and where success has not yet been established. Early entrants into a market often make mistakes that eat up cash and time. By coming along with fresh cash and avoiding those mistakes a "fast follower" can sweep in and take the market.
Having said that though there are some clear dangers of copying business models that anyone attempting to do so should be aware of and prepared for.
The first and most dangerous is that copying a business model means observing what another company does and then attempting to replicating its moves. However as Sun Tzu says "All men can see the tactics by which I conquer, but what none can see is the strategy out of which victory is evolved". What this means is that you can copy what you see but there may be vital information in what you can't see — the strategy behind what you see. If moves are well timed or depend upon hidden information you may do the same things but not get the right response.
Your thinking becomes tied to a competitor. Copying can become a habit and it can make you reactive and develop inertia in your thinking.
Copying a model means doing what someone has done in the past. This can put you "behind the curve" when you need to be ahead of it. It's not always a problem but it can be and in time-sensitive businesses, it can be the difference between success and failure.
Copying a model means deferring some of your strategy and decision making to others. This can make it very hard to develop a "compass" of your own. If your copied model stops working or doesn't work as well as you'd hope you may be rather at sea in trying to fix it.
Regardless of whether you choose to replicate a business model it's valuable to study business models and understand how they work. It's not necessary to replicate the whole model and often a successful company is translating an innovation in a different market or industry to turn things upside down.
“Success, in the long run, has less to do with finding the best idea, organizational structure, or business model for an enterprise, than with discovering what matters to us as individuals.”
A business model is a high-level summary of how a business intends to operate: where it will look for customers, how it will serve them, how it will generate it's own value, and so on.
A business strategy encompasses the business model. The core of a strategy is a set of objectives that represent what the strategy is meant to deliver, a diagnosis of the challenge those objectives represent, an understanding of the critical factors that must be handled to overcome the challenge and a set of guidelines about the kind of activities the business will use to address those factors.
We can think of the business model as being a description of the moving parts of those activities. We deduce the business model in response to the strategy.
In particular we can think of a business model as being a response to a strategy. For any given strategy there may be an almost infinite number of business models you could come up with to deliver on the strategy. Clearly some are going to be better than others although there may be no one "right" business model.
To give a concrete example:
Imagine we had a strategy that talked about serving meals to people in a pandemic where we had objectives around the number of meals we want to serve, the amount of revenue we wanted to generate, and the valuation we wanted to achieve at our next funding round.
What would we diagnose as the major challenge here? It might be producing meals or it might be delivering meals.
This could lead to a range of different business models.
Would we be setting up kitchens in local areas?
This would give us a lot of control over product but probably a lot of overheads and staffing costs.
Would we utilise spare restaurant capacity?
This would present partnership opportunities and initial costs low. But in the long-run we might have less control over product and it might be scalable.
Would we use a hybrid model?
Perhaps we could implement "super kitchens" and augment 'surge' capacity by taking over local spare capacity
Our strategy might set out constraints that would feed into this business model. If part of our strategy was to support existing restaurants then it would drive us towards using them and away from creating our own capacity.
“A business model describes the rationale of how an organization creates, delivers, and captures value.”
A business model is a summary of the key elements of how a business works which is to say how it will acquire customers, what it is that they will pay for, and how it extracts value from the equation.
A good business model exposes the key assumptions being made and makes them easier to test allowing the business to have a better chance of being successful.