Table of Contents
- What is a business model
- Types of business models
- How to choose a business model that works
- Closing thoughts on choosing the right business model
Do you want to start a business? Are you looking for getting money from VCs? One of the first question slapping your face when pitching investors or your co-founder is how will your business make money. Fortunately, there is a tool dedicated to give you this and other answers and it is called a business model. In this post, you will learn what business model is and what types are available for you to try. Are you ready to take the leap?
What is a business model
To answer this question and define what business model is can be quite hard. Even though everyone agrees that you must know how business model work to allow your business to thrive, there is almost no universal definition of it. Some experts define a business model by specifying the main characteristics of a good one. For example, Clay Christensen suggests that a business model should consist of four elements: a customer value proposition, a profit formula, key resources, and key processes.
Dividing business plan into these detailed categories can help you evaluate your business model, but they also create limitations and preconceptions about what business plan should look like. This, in turn can constrain or even prevent the development of radically different ones. Some studies suggest that business model must include the choices that you make about how your business should work. The simplest concept of a business model consists of a set of choices managers and business owner have to do and their consequences.
For purposes of this post, let’s define business model as a range or set of instructions that represent core aspects of a business. These instructions include purpose of the business, business process, target customers, offerings, strategies, infrastructure, organizational structures, sourcing, trading practices, and operational processes and policies. In its simplest terms, business model have to give you an idea about how do you plan to make money.
I should also mention that business plan is nothing rigid that cannot be changed. In a fact, there is a group of people like Alex Osterwalder, the author of Business Model Generation book, saying that a business model is really a set of assumptions or hypotheses. Steve Blank is even known for saying that no business plan survives first contact with a customer. What’s more, in his opinion, business plan is what actually causes death of a startup. In order to avoid this your business model has to change and adapt to market on continuous basis.
The takeaway is this … Business model is a tool that should tell you how will you make money and how will you give value to your customers. It is nothing that should be set in stone and never changed, rather the opposite. It should evolve over the time as the market will go through changes. Business model also does not have to be anything complicated. The simpler it will be, the easier it will be to test it.
Types of business models
After you get to know to what business model is, or should be, let’s take a look at what types are available. I used various resources including sites like Harvard Business Review many more to put together a list comprehensive enough to help you choose which business model is right for you, but not to choke you with data (at least I hope).
Let’s start with one of the most used business models on the web. If you ever visited almost any website, you are already familiar with advertising model. This model is basically an extension of the traditional media broadcast model where a web site provides content (free of paid) mixed with advertising messages in the form of banner ads. Many online blogs are using this as their source of revenue. One of the more extreme examples of this business model is The Million Dollar Homepage.
The affiliate model provides users with opportunities to purchase various products or services by linking to their providers. Owner of the website makes revenue through getting specific percentage of the price the product or service cost. For example, if you have a book club, you can sign a contract with Amazon or other bookstore and then reference on their site to sell people the books you are talking about and get percentage from every sale.
Brokerage business model is based on bringing together buyers and sellers to make some transactions and charging a specific fee for doing it.
When you get to selling products or services, you can either sell them piece by piece or package related products together and sell them in one big bundle. Another way is to use bundling as an extension of your current business. Meaning, you can offer products and services separately for one price while also create a special bundles for a different price points. This commonly used pricing strategy in product development is called tier pricing.
Note on tier pricing: What is beautiful on tier pricing is that it can work for almost anyone and any business. This pricing strategy is based on providing your product or service at different price points. Almost every business you encounter uses it in some way. Remember that Free, Pro and Enterprise plan on Hootsuite? How about those different shipping options on Amazon? Well, that’s tiered pricing in action. Tier pricing can be based on quantity, quality, perceived quality (hardcover vs. paperback book), additional service, speed, experience, customization and so on.
This business model is a result of today’s more and more connected world where people from across the globe can come together and bring together resources needed to make their business idea reality. The most famous example of crowdsourcing is platform called Kickstarter. A bit different examples include web sites like Wikipedia and YouTube where content is created and curated by community of users who, in turn, get access to content created by other people.
Fractionalization model is based on selling partial usage, separate parts or sections of some product and services. Let’s say you have a pizza stand. You can sell the pizza as one piece (product) or cut it into several pieces and sell them separately. This also allows you to create variations of your products (one piece of spinach pizza and one piece of salmon pizza), extend the range of products you offer and bring you more customers.
Freemium model is often used in app development. It is based on offering basic version of your product or service for free to everyone and charge users if they want to switch to premium version. Best examples of this business model are apps for smartphones. In free version you can use only specific features of the app or game. If you want more, you can either unlock it through in-app purchase or buy a plan (subscription).
Have you ever though about buying a car? Well, then you would probably hear about financing it through leasing. In leasing model, instead of selling products or services you are renting them. User have access to product, say car, and can use it as he wishes, but it is not owned by him. It car still belongs to you and he is paying you for using it. The same applies to renting a house. You pay monthly rent to owner of property and in return you can live there. Tuition fee for school? The same thing. You pay, they provide you with what you need.
Low-touch model is based on offering products for lower prices by decreasing services the will get with the product. One example is retailer IKEA. They are able to offer furniture and other products for lower prices because the additional services like putting the furniture together is outsourced to the customer.
This business model is probably the oldest one. It includes wholesalers and retailers of any goods and services you can think about. Revenue, in this model, is based on selling products for fixed prices or through auction.
The manufacturer, also known as “direct model”, is predicated on the power of the web to allow a manufacturer to reach buyers directly without any middlemen or other middle steps. This way, the channel stays very narrow and whole profit from sales goes to the company. This business model is also known as “disintermediation”. Example of this model is computer manufacturer Dell.
Negative operating cycle
Negative operating cycle is based on charging lower prices by receiving payments from customers before delivering them the products. In other words, you are paying upfront.
Do you have an ink printer? If yes, how much did it cost? In most cases, the price was not that high. The ink you need to buy into it is a different story. The same thing with selling razors for lower price and then charging more for a replaceable blades. In other words, you sell high-margin product for lower price in order to increase the demand for low-margin companion product you need to buy as well (razor and blades, printer and cartridges).
In contrast to Razor/blades business model, you are selling the main products for a high price while selling the companion products relatively cheaply. Examples of this model can be Apple selling iPod at high price while offering songs for much lower prices. The same thing with Amazon selling expensive Kindle and cheaper books.
Product to service
Product to service is based on selling service the product performs instead of selling the product itself. Example of this model can be Zipcar. You are not selling the car itself, but what it performs–driving and getting from point A to point B.
This business model is based on charging the users a periodic–daily, monthly or annual–fee to gain access to a service. For example, Netflix, Spotify (premium) or your ISP (Internet access provider) use this model.
User community business model is somewhat similar to subscription. You are again charging the users, members of community, specific fee to gain access to the network (community). Community model is based on user loyalty. Meaning, users are investing their time and emotion into the community. This, as a result, will make them come back in the future. Revenue in this business model can be based on advertising, selling products and services or on asking for voluntary contributions. The last example is what Brain Pickings website by Maria Popova uses as its business model.
The utility or “on-demand” business model is based on measuring how much the users are utilizing a service and then charge them for this usage. You can also call this model a “pay as you go”. There is no fixed price like in subscription or community based models. Another benefit of this model is that users are not tied to using the service and can terminate it any time without causing you headaches. However, if your business is based on making harder for users to leave it, this business model is probably not for you ;).
How to choose a business model that works
Some business models are as old as the marketplace itself like the merchant, manufacture or brokerage. Others are younger and less tested and many of them came with the rise of the Internet. Some of the models mentioned have endured the test of time and proved to be sustainable while others are experimental without any evidence to support them. If you are not sure about which model to choose without putting yourself at risk, make it simple.
If you purge every business model to the simplest terms and analyze it, you will find out that the best options are to create a product and sell it either directly to customers or to wholesale to retailers, selling through distributors, licensing products to other companies, selling online, selling through auctions, and so on. In the end, it is all about having a product or service and someone to sell it to.
Anyway, I think we can agree on one thing … In order to be good and useful, every business model needs to answer questions uttered by Peter Drucker. These questions are: “Who is the customer?” “What does the customer value?” Also, it has to answer the questions every manager have to ask: “How do we make money in this business?” and “How we can deliver value to customers at an appropriate cost?” If your business model is able to give you these answers, you are good to put it in practice and test it in.
Closing thoughts on choosing the right business model
Keep in mind that there is no one-size-fits-all solution. When you take a look at the most companies, they often use some combination of two or more business models to create a completely new and unique model. You can do the same thing. Instead of picking one model, select your favorite ones and combine them together. Also, nobody says you have to follow prescribed instructions … Why not to put together you own business plan?
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