When planning to setup a business, there are many crucial business decisions you have to make. One such decision is what kind of business you will create. There are different types of business models to choose from. If you are planning to build your business from scratch, the business model you choose will be crucial to the success of your business. Business models are important for both new and established businesses. In this article, we shall cover the following topics:
1. What are Business Models?
2. Components of a Business Model
3. Benefits of a Business Model
4. Steps In Choosing A Business Model
5. Types of Business Models
6. Mistakes That Can Kill Your Business Model
What are Business Models?
In general, a business model is a company’s core strategy for profitability. It explains how the company plans to add value and make money. Business models identifiy the products or services the business plans to sell, their target market, and anticipated expenses.
In choosing a business model, it is imperative for you to understand how your business will generate a profit. Your business model should allow you to remain profitable after startup and additional costs are factored into the equation.
Components of a Business Model
There are various types of business models to choose from. Whatever it is you choose, they will most likely have the following essential components:
- Value proposition. This is the feature of the business model that explains what makes your product attractive to customers and what sets it apart from the competition.
- Target Market. These are the people who would be interested in buying your product
- Competitive advantage. This is a feature of your product or service that cannot be easily duplicated by competitors
- Cost structure. These are the fixed and variable expenses required by your business to function and how it will impact cost.
- Key metrics. This represents the way your company will measure success
- Resources. Physical, financial, and intellectual assets of your company
- Problem and solution. These are the pain points of your target customers and how your company intends to address them
- Revenue model. A framework that identifies viable income sources to pursue
- Revenue streams. The multiple ways your business can gain profit
- Profit margin. The amount your revenue exceeds business costs
Benefits of A Business Model
A business model provides organizations with an outline of specific processes, functions, or activities they can use to produce consumer goods and services in the business environment. Business models are designed to ensure that companies can produce goods and services efficiently and effectively. When properly implemented, business models can provide benefits to companies.
Business models provide companies with some level of organization to ensure smooth flow of information through the company. A disjointed company can experience difficulty in maintaining needed information to report on current business practices. By learning the different types of business models, you can organize the company due to the number of divisions or departments. It can help companies develop strategic relationships for acquiring economic resources at the lowest cost or build a supply chain for goods delivery to consumers.
Repetition is the ability of a company to consistently complete certain business tasks or activities today, tomorrow, and in the future. Business models allow companies to refine their processes to eliminate waste and any unnecessary steps in the business process. In addition, it gives business owners and managers time to preview their processes to ensure that it is the best way to accomplish these tasks and functions.
The different types of business models give companies the ability to produce goods and services that are better than their competitors. Competitive advantages can also be achieved through customer service interactions or skilled employees. If you have a unique business model, it will be hard for the competition to copy it.
Steps in Choosing The Right Business Model
All right, you have an innovative product but providing solutions doesn’t mean your business will be successful. The business model needs to be the right one for the product you are selling. You need the right price, messaging, delivery channel, and right target market. The right product should come from the right business model. Here are some steps on how to choose the right business model:
- Determine market potential. It would be a good idea for you to check how big your potential market will be. It’s okay for you to enter a narrow niche but it will make a difference if the market has a greater potential.
- Competitive Landscape. You must understand your competitors and what their value proposition is. Having competitors who have the same demand for your idea is not a bad thing.
- Ideal Customer. Define the characteristics and qualities of the customer you are targeting. From there you can get a better view of your market size and how to best target it.
- Value Proposition. This is the question that your product should answer: Why your product? What makes your product unique and why should customers choose it?
- Distribution Channels. How are you going to get your product, service, or idea to the market? Direct sales force, distributors, eCommerce sites, retail stores, and others are all options. There are instances when you might need to combine all distribution methods. This is an important decision as your profit and expenses will depend on your chosen business model.
- Revenue Stream. Your business should have a core way of making money. A strong business model should take into consideration ways to add value and make money. It could be through sales of products or convergence of several assets, and others.
- Strategic Relationships. Most business models hinge on developing partnerships with companies that have products or services central to their model. A software company, for example, may need to forge relationships with key software companies to build their business.
Types of Business Models
Now that you have an idea of what a business model is and its elements, let us take a look at the different types of business models you can consider setting up.
1. Subscription Model
In this business model, a customer pays a recurring monthly payment in exchange for a product or service. The company may directly ship their product to you or you may pay a fee for using an app. Good examples of this model are streaming services like Netflix and Spotify.
2. Bundling Model
From the name itself, these business models involve companies selling two or more products as a single unit for a lower price than they would sell the products individually. Bundling models provide companies with greater volume of sales in the process marketing products or services that are difficult to sell. The disadvantage of this model is that the profit margins also decrease because products are sold for less.
Examples of companies using the bundling model are fast-food chains like Burger King that offer value meals or deals as well as technology companies like AT&T and Adobe Creative Suite.
3. Freemium Model
The basic framework of freemium models is the provision of a proprietary tool for users to freely access an app or tool suite. The company withholds or limits the use of certain key features that users will most likely want to use on a regular basis. To make those features available to them, users must pay a subscription fee.
The free version of Spotify is an example of a freemium model. They provide free and open access to their music database while sprinkling in ads between songs. At some point, users may go for the premium version so that they can play music without the ads.
4. Razor Blades Model
As you know, replacement razor blades are often more expensive than the razors themselves. The razor blade model is based on the assumption that customers will continue to buy more expensive accessories in the future. Other companies use the reverse razor blade model by offering a high-margin product to promote the sales of lower margin products that go with the initial product.
A good example is Apple iPhones and Macs. Consumers buy phones or computers and then Apple pushes additional products, tools, and services that accompany the item.
5. Product to Service Model
In this type of business model, you ask the help of another company in creating a product. Imagine that you own a scooter manufacturing company. Let’s say you need to weld two pieces of metal together. You might solicit the help of another company to do the welding instead of purchasing a welding machine yourself. This is how the product to service model works. You purchase a result instead of the equipment that delivers the result. Examples of companies that use the product to service model include Zipcar, Uber. Lyft, and LIME.
6. Leasing Model
In a leasing business model, a company buys a product from a seller. That company will then let another company use the product they purchased for a periodic fee. Leasing agreements are most applicable in items like manufacturing and medical equipment. Examples of this business model include U-Haul, Enterprise, and Rent-a-Center.
7. Crowdsourcing Model
Crowdsourcing involves receiving opinions, information, or work from different people through the internet or social media. These business models utilize a vast network of talent without having to hire in-house employees. Examples are traffic apps that encourage drivers to report real-time accidents for the benefit of other app users. Companies that use the crowdsourcing model include Wikipedia, YouTube, IMDB, and Indiegogo.
8, One-for-One Model
In this business model, a company donates one item to charity for every item purchased. This is an appealing model given the charitable nature and social consciousness of customers and it will encourage the customer to buy a product or service. This allows both your company and customer to actually engage in philanthropic efforts.
TQMS pioneered in this business model. Other examples include SoapBox, Smile Squared, and Warby Parker.
9. Franchise Model
Of all the different types of business models, people are most familiar with the franchise model. Surely you had already eaten in Starbucks, McDonald’s, Subway, and others. These are popular franchises. In this business model, the franchiser works with the franchise in the aspects of financing, marketing, and other business operations to ensure smooth functioning of the franchise.
10. Distribution Model
A company operating as a distributor is responsible for taking manufactured goods to the market. A good example is Hershey’s, which manufactures and packages chocolates but it is the distributors that transfers and sell the goods from the factory to the retailer. To gain a profit, distributors will buy the product in bulk and sell it to retailers at a higher price.
Examples of companies that use the distribution model include HD Supply, Avent, Cheney Brothers, and ABC Supply Co
11. Manufacturer Model
The manufacturer model is another one of the most traditional business models. In this model, the manufacturer converts raw materials into a product. Companies like Dell computers or Hewlett Packard, both of which assemble computers with parts manufactured by other companies. Other examples of business this model include Intel, Magic Bullet, Black & Decker, and LG Electronics.
12. Retailer Model
Retailers are the last link in the supply chain. These businesses purchase goods from distributors and then sell them to customers for a price that covers expenses and turns a profit. Retailers may specialize in a particular niche such as kitchenware or carry a range of products. Examples of companies using the retailer model include Nordstrom, Home Depot, Target, and Best Buy.
4 Mistakes That Can Kill Your Business Model
Running a business can be daunting and you are bound to make mistakes along the way. However, you want your mistakes to be small and manageable. Here are four major mistakes that could ruin your business model for a long time.
1. Solving an Irrelevant Customer Job
Different types of business models will fail if it is built around a value proposition for a customer job they don’t care about. In startup business parlance, this is called failure to achieve product market fit. There will be no business that will survive for long without product-market lift. This mistake happens when you focus too much on products, services, technologies, and features. You should first focus on determining what jobs customers are trying to get done.
2. Flawed Business Model
No matter how great your product or technology is but the business model isn’t appropriate, it is doomed to fail. Flawed business models will fail even if your value proposition is what customers crave for. The biggest flaw is when the value proposition generates more cost than revenues from customers.
3. Neglecting External Threats
Failure is still inevitable even if your business model is solving relevant customer jobs and you have a sound design. Your failure will come from external sources. The most obvious outside threat is your potential competitors. The most successful companies always examine their business model to stay abreast of possible threats to your business model.
4. Poor Execution
If your company resources are not properly aligned around the most crucial elements of your business model, it is still possible to fail. Most successful businesses measure and monitor a lot of factors but they do not start from their business model. Regular measurement and monitoring of success factors can ensure proper alignment of resources around your model.