Definition of Business Model
Established businesses should regularly update their business model or they'll fail to anticipate trends and challenges ahead. Business models also help investors evaluate companies that interest them and employees understand the future of a company they may aspire to join.
What is a Business Model
A company isn't just an entity that sells goods. It's an ecosystem that must have a plan in plan on who to sell to, what to sell, what to charge, and what value it is creating. A business model describes what an organization does to systematically create long-term value for its customers.
Successful businesses have business models that allow them to fulfil client needs at a competitive price and a sustainable cost. Over time, many businesses revise their business models from time to time to reflect changing business environments and market demands.
Why is it relevant?
Understanding a business model is at the core of organizational strategy, competitiveness, and business sustainability.
When evaluating a company as a possible investment, the investor should find out exactly how it makes its money. This means looking through the company's business model. Admittedly, the business model may not tell you everything about a company's prospects. But the investor who understands the business model can make better sense of the financial data.
What is a Business Model Analysis?
A business model (BM) analysis explains how companies perform business through an articulated set of activities in order to create and deliver value to stakeholders.
The Activity System (AS) perspective offers a way to understand how value is created since it explains what companies actually do through their activities (link).
BM analysis helps to understand how competitors act in an industry. It is possible to compare BMs that compete in the same industry to understand the differences in how they create and deliver value.
Types of Business Models: some examples
There are as many types of business models as there are types of business. For instance, direct sales, franchising, advertising-based, and brick-and-mortar stores are all examples of traditional business models. There are hybrid models as well, such as businesses that combine internet retail with brick-and-mortar stores or with sporting organizations like the NBA.
A retailer is the last entity along a supply chain. They often buy finished goods from manufacturers or distributors and interface directly with customers. Example: Costco Wholesale
A manufacturer is responsible for sourcing raw materials and producing finished products by leveraging internal labor, machinery, and equipment. A manufacturer may make custom goods or highly replicated, mass produced products. A manufacturer can also sell goods to distributors, retailers, or directly to customers. Example: Ford Motor Company
Instead of selling products, fee-for-service business models are centered around labor and providing services. A fee-for-service business model may charge by an hourly rate or a fixed cost for a specific agreement. Fee-for-service companies are often specialized, offering insight that may not be common knowledge or may require specific training.
Example: DLA Piper LLP
Subscription-based business models strive to attract clients in the hopes of luring them into long-time, loyal patrons. This is done by offering a product that requires ongoing payment, usually in return for a fixed duration of benefit. Though largely offered by digital companies for access to software, subscription business models are also popular for physical goods such as monthly reoccurring agriculture/produce subscription box deliveries.
Freemium business models attract customers by introducing them to basic, limited-scope products. Then, with the client using their service, the company attempts to convert them to a more premium, advance product that requires payment. Although a customer may theoretically stay on freemium forever, a company tries to show the benefit of what becoming an upgraded member can hold.
Example: LinkedIn/LinkedIn Premium
If a company is concerned about the cost of attracting a single customer, it may attempt to bundle products to sell multiple goods to a single client. Bundling capitalizes on existing customers by attempting to sell them different products. This can be incentivized by offering pricing discounts for buying multiple products.
Marketplaces are somewhat straight-forward: in exchange for hosting a platform for business to be conducted, the marketplace receives compensation. Although transactions could occur without a marketplace, this business models attempts to make transacting easier, safer, and faster.
Affiliate business models are based on marketing and the broad reach of a specific entity or person's platform. Companies pay an entity to promote a good, and that entity often receives compensation in exchange for their promotion. That compensation may be a fixed payment, a percentage of sales derived from their promotion, or both.
Example: social media influencers
Aptly named after the product that invented the model, this business model aims to sell a durable product below cost to then generate high-margin sales of a disposable component of that product. Also referred to as the "razor and blade model", razor blade companies may give away expensive blade handles with the premise that consumers need to continually buy razor blades in the long run.
Example: HP (printers and ink)
Reverse Razor Blade
Instead of relying on high-margin companion products, a reverse razor blade business model tries to sell a high-margin product upfront. Then, to use the product, low or free companion products are provided. This model aims to promote that upfront sale, as further use of the product is not highly profitable.
Example: Apple (iPhones + applications)
The franchise business model leverages existing business plans to expand and reproduce a company at a different location. Often food, hardware, or fitness companies, franchisers work with incoming franchisees to finance the business, promote the new location, and oversee operations. In return, the franchisor receives a percentage of earnings from the franchisee.
Example: Domino's Pizza
Instead of charging a fixed fee, some companies may implement a pay-as-you-go business model where the amount charged depends on how much of the product or service was used. The company may charge a fixed fee for offering the service in addition to an amount that changes each month based on what was consumed.
Example: Utility companies
Brokerage A brokerage business model connects buyers and sellers without directly selling a good themselves. Brokerage companies often receive a percentage of the amount paid when a deal is finalized. Most common in real estate, brokers are also prominent in construction/development or freight. Example: ReMax
A Single Company can Implement Different Business Models: an example
Consider the vast portfolio of Microsoft. Over the past several decades, the company has expanded its product line across digital services, software, gaming, and more. Various business models, all within Microsoft, include but are not limited to:
Productivity and Business Processes: Microsoft offers subscriptions to Office products and LinkedIn. These subscriptions may be based off product usage (i.e. the amount of data being uploaded to SharePoint).
Intelligent Cloud: Microsoft offers server products and cloud services for a subscription. This also provide services and consulting.
More Personal Computing: Microsoft sells physically manufactured products such as Surface, PC components, and Xbox hardware. Residual Xbox sales include content, services, subscriptions, royalties, and advertising revenue.
A practical guide for Business Model Analysis
https://www.redalyc.org/journal/841/84163124005/html/#f3:~:text=Results%3A A Prescriptive Method for Business Model Analysis
The proposed artefact is a method for business model analysis. It has three pillars: dimension analysis, representation of BM, and competitive analysis. First, the dimension analysis examines how a company creates value through its AS.
First pillar: dimension analysis
link —> descriptions of the practical questions on the bottom
Second pillar: visual representation of the BM
Third pillar: competitive analysis
link —> The Third Pillar offers opportunities to explore strategic issues related to the companies’ BM.