Business model

A business model describes the rationale of how an organization creates, delivers, and captures value^[1] - economic, social, or other forms of value. The term business model is thus used for a broad range of informal and formal descriptions to represent core aspects of a business, including purpose, offerings, strategies, infrastructure, organizational structures, trading practices, and operational processes and policies.

Overview

To create a formal business model, one must first formalize their informal descriptions for the business. These formal descriptions become the building blocks for the business's activities. Many different business conceptualizations exist; Alexander Osterwalder's 2004 thesis^[2] proposes a single reference model based on the similarities of a wide range of business model conceptualizations. With his business model design template, an enterprise can easily describe their business model:

File:Business model components.png

Business model design template: Nine building blocks and their relationships, Osterwalder 2004^[2]

Infrastructure

Core capabilities:The capabilities and competencies necessary to execute a company's business model.
Partner network: The business alliances which complement other aspects of the business model.
Value configuration: The rationale which makes a business mutually beneficial for a business and its customers.

Offering

Value proposition: The products and services a business offers. Quoting Osterwalder (2004), a value proposition "is an overall view of .. products and services that together represent value for a specific customer segment. It describes the way a firm differentiates itself from its competitors and is the reason why customers buy from a certain firm and not from another."

Customers

Target customer: The target audience for a business' products and services.
Distribution channel: The means by which a company delivers products and services to customers. This includes the company's marketing and distribution strategy.
Customer relationship: The links a company establishes between itself and its different customer segments. The process of managing customer relationships is referred to as customer relationship management.

Finances

Cost structure: The monetary consequences of the means employed in the business model. A company's DOC.
Revenue: The way a company makes money through a variety of revenue flows. A company's income.

History

A brief history of the development of business models might run as follows. The most known and most basic business model is the shopkeeper model. This involves setting up a store in a location where potential customers are likely to be and displaying a product or service.

Over the years, business models have become much more sophisticated. The bait and hook business model (also referred to as the "razor and blades business model" or the "tied products business model") was introduced in the early 20th century. This involves offering a basic product at a very low cost, often at a loss (the "bait"), then charging compensatory recurring amounts for refills or associated products or services (the "hook"). Examples include: razor (bait) and blades (hook); cell phones (bait) and air time (hook); computer printers (bait) and ink cartridge refills (hook); and cameras (bait) and prints (hook). An interesting variant of this model is a software developer that gives away its word processor reader free of charge but charges several hundred dollars for its word processor writer.

In the 1950s, new business models came from McDonald's Restaurants and Toyota. In the 1960s, the innovators were Wal-Mart and Hypermarkets. The 1970s saw new business models from FedEx and Toys R Us; the 1980s from Blockbuster, Home Depot, Intel, and Dell Computer; the 1990s from Southwest Airlines, Netflix, eBay, Amazon.com, and Starbucks. Poorly thought out business models were a problem with many dot-coms.

Today, the type of business models might depend on how technology is used. For example, entrepreneurs on the internet have also created entirely new models that depend entirely on existing or emergent technology. Using technology, businesses can reach a large number of customers with minimal costs.

Examples

Applications

Malone et al.^[3] at MIT find that some business models, as defined by them, indeed performed better than others in a dataset consisting of the largest U.S. firms, in the period 1998 through 2002, while they did not prove whether the existence of a business model mattered.

Perhaps the most overlooked dimension in developing a business model especially for a new product/service/business is the dimension of time, more specifically the timing of investments/expenses or cash flow out versus the receipt of revenues/accounts receivables or cash flow in. The principle issues are: 1) Essentially how much of the product or service has to be built before customers can make some level of either actual purchase decision and/or purchase commitment? 2) How much investment/expense is required to secure these revenues/commitments from customers? and 3 )How much risk is there in achieving net positive cash flow, given the required upfront investment and the future time to capture revenues/receivables cash inflow, within an acceptable timeframe, if ever?

These business model issues often make or break new ventures. Business models that are optimized to reduce the upfront investment, that accelerate the revenue/receivables cash inflow, that obtain cogent and reliable customer feedback often and earlier, and that take other measures to reduce the investment risk all have a higher probability of business success.

For example, in the entertainment industry, does one have to produce a movie for $100 million plus before any box office revenues can be derived, or can the business model be evolved by licensing certain established characters/signing leading movie stars for secondary licensing rights for fast-food chain promotional-tie-ins, movie merchandise licenses, etc. can generate pre-release cash inflow through licensing fees? Or a different entertainment business model might be to create and promote a "Weirdest Video" website platform for users to contribute the content and then based on site traffic, sell advertising for revenues. Here, the upfront investment for creating and promoting the site could be a fraction of the investment to produce a movie and the chances that it would be more popular than a movie may be much higher, as it can be tweaked as it is developed while a movie is an all-or-nothing production.

It comes down to a nitty gritty question: Can we make to order or do we have to create a new mousetrap and then wait to see if the world will come to it, or somewhere in-between?

Related Concepts

The process of business model design is part of business strategy. The implementation of a company's business model into organizational structures (e.g. organigrams, workflows, human resources) and systems (e.g. information technology architecture, production lines) is part of a company's business operations. It is important to understand that business modeling commonly refers to business process design at the operational level, whereas business models and business model design refer to defining the business logic of a company at the strategic level. The brand is a consequence of and has a symbiotic relationship with the business model since the business model determines the brand promise and the brand equity becomes a feature of the model. Managing this is a task of Integrated Marketing.

References

^ Business Model Generation, A. Osterwalder, Yves Pigneur, Alan Smith, and 470 practitioners from 45 countries, self published, 2009
^ ^a ^b The Business Model Ontology - A Proposition In A Design Science Approach
^ Do Some Business Models Perform Better than Others?, Malone et al., May 2006

External links

[1] Business Model Generation, A. Osterwalder, Yves Pigneur, Alan Smith, and 470 practitioners from 45 countries, self published, 2009

[Osterwalder2004-2] The Business Model Ontology - A Proposition In A Design Science Approach

[3] Do Some Business Models Perform Better than Others?, Malone et al., May 2006

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