What is a Business Model?
A few definitions
According to Wikipedia:
A business model describes the rationale of how an organization creates, delivers, and captures value, in economic, social, cultural or other contexts. The process of business model construction and modification is also called business model innovation and forms a part of business strategy.
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.
According to Investopedia:
The term business model refers to a company's plan for making a profit. It identifies the products or services the business plans to sell, its identified target market, and any anticipated expenses. Business models are important for both new and established businesses. They help new, developing companies attract investment, recruit talent, and motivate management and staff. Established businesses should regularly update their business plans or they'll fail to anticipate trends and challenges ahead. Business plans help investors evaluate companies that interest them.
According to feedough.com:
A business model is a conceptual structure that supports the viability of the business and explains who the business serves to, 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.
An ideal business model usually conveys four key aspects of the business which is 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?
🔎 Key Takeaways
A business model is an outline of how your business will generate a profit. The plan includes important information like target market, market need, and details on business expenses.
There are lots of types of business models, and models can be combined as well. You’re probably familiar with some of the more common ones like manufacturer, distributor, retailer, and franchise.
When creating a business model, you should be clear about who your target customer is and how you’ll reach them. You’ll also want to know specifics about what you’re selling, and what sets you apart from your competition.
The Business Model Canvas
You should have a clear idea on what a Business Model is and maybe it is easier now to understand what the Business Model Canvas is for.
Download the PDF and try to fill it in with your business idea, see what comes out.
A common mistake many companies make when they create their business models is to underestimate the costs of funding the business until it becomes profitable. Counting costs to the introduction of a product is not enough. A company has to keep the business running until its revenues exceed its expenses.
One way analysts and investors evaluate the success of a business model is by looking at the company's gross profit. Gross profit is a company's total revenue minus the cost of goods sold (COGS). Comparing a company's gross profit to that of its main competitor or its industry sheds light on the efficiency and effectiveness of its business model. Gross profit alone can be misleading, however. Analysts also want to see cash flow or net income. That is gross profit minus operating expenses and is an indication of just how much real profit the business is generating.
The two primary levers of a company's business model are pricing and costs. A company can raise prices, and it can find inventory at reduced costs. Both actions increase gross profit. Many analysts consider gross profit to be more important in evaluating a business plan. A good gross profit suggests a sound business plan. If expenses are out of control, the management team could be at fault, and the problems are correctable. As this suggests, many analysts believe that companies that run on the best business models can run themselves.
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Types of Business Models
Here are a few commonly used business models that you’re probably familiar with. Remember that there are many different types of business models and multiple models can be combined to create a new approach.
This type of business model is when a company makes a product from raw materials or assembles prefabricated items to create new merchandise. The business can sell the items directly to consumers itself, which is a business-to-consumer (B2C) model, or it can use a business-to-business (B2B) model in which it sells to other businesses.
An example of a B2C manufacturer would be a shoe company that sells its products directly to customers. A B2B manufacturer would be a business that sews dresses and only sells its products wholesale to other businesses, which then sell the dresses to the general public.
The distributor business model is when a company purchases inventory from a manufacturer and sells it to either a retailer or directly to the public. A common challenge that distributors face is picking the right price point that allows them to make a profit on the sale, but still offers competitive pricing. An example of a distributor would be a company that buys soft drinks from a manufacturer and sells those beverages to restaurants at a higher price.
Retail business models are those used by companies that buy inventory from a manufacturer or distributor and sell those products to the public. Retailers can range from a single mom-and-pop shop to huge chain stores—they often have brick-and-mortar locations, an online store, or both.
An example of a retailer would be a hat store that buys the products from a distributor. A limited selection of the hat store’s products is available at its brick-and-mortar storefront, but its full inventory can be purchased online.
The franchise business model can be applied to other business models, like the ones we just discussed. The franchisee takes on the business model of the franchise and with it, the latter’s pre-established processes and protocols. Examples of popular franchises include McDonald’s, KFC, Burger King, and 7-Eleven.