In the world of small business, a business model is like the architectural blueprint of a building. It lays out how a company intends to operate, generate revenue, and sustain itself in the long run. A well-defined business model is important because it helps entrepreneurs understand their market, allocate resources efficiently, and communicate their value proposition to stakeholders.
Just like a chef needs a recipe to prepare a dish, a business owner needs a business model to steer their company towards success.
What Are the Components of a Business Model?
To build a successful business, you should begin by understanding the key components of a business model. These elements collectively define how a business creates, delivers, and captures value.
Here’s a breakdown of each component:
Value Proposition: This is the unique mix of products and services that a business offers to meet the needs of its customers. It’s what makes the business stand out in the market and attract customers.
Customer Segments: These are the specific groups of people or organizations that the business aims to serve. Understanding these segments allows businesses to tailor their offerings to meet the unique needs of each group.
Channels: These are the means through which a business delivers its products or services to its customer segments. Channels can include physical stores, online platforms, or direct sales teams.
Customer Relationships: This component describes the types of relationships a business establishes with its customer segments. These relationships can range from personal, such as dedicated account managers, to automated, such as self-service platforms.
Revenue Streams: These are the various ways a business earns money from each customer segment. This can include one-time sales, recurring subscriptions, or licensing fees.
Key Activities: These are the most important actions a business must take to deliver its value proposition. Key activities can include production, problem-solving, or platform/network maintenance.
Key Resources: These are the assets required to perform the key activities and deliver the value proposition. Resources can be physical (such as manufacturing plants), intellectual (such as patents), human (such as skilled employees), or financial.
Key Partnerships: These are the network of suppliers, partners, and stakeholders that a business relies on to function. Partnerships can help reduce risks, acquire resources, or enhance the value proposition.
Cost Structure: This outlines the costs involved in operating the business, including the expenses associated with key activities, resources, and partnerships.
As you are contemplating documenting these different components of your business model, it might help you to think of each of these sections as a puzzle piece that slots together with other pieces of your business.
Business Model vs. Business Plan
What’s the Difference?
Many within the business world use the terms business plan and business model interchangeably. Just know that when you see this happen (and you will), know that these poor souls have very little understanding of either of these terms, which puts you at an advantage!
What these folks don’t understand or were never taught was that these two terms/documents serve very distinct purposes within a company’s strategy.
A business model is a conceptual framework that outlines how a business creates, delivers, and captures value. It focuses on the components that make the business work, such as the value proposition, customer segments, revenue streams, and cost structure.
On the other hand, a business plan is a detailed document that describes the company’s goals, strategies, market analysis, and financial projections. It acts as a roadmap for the business, guiding its operations and growth over time.
When you are contemplating starting a business and making decisions about your business plan, understand that a business plan typically includes the business model as one of its components! If you’d like to learn more about Business Models, I highly recommend the book “Business Model Generation.” This book is on my personal book shelf and I use it often as reference and inspiration. (I receive no kickbacks on this book, it's just a good reference)
What Are Some Common Business Models?
Subscription Model:
In the subscription model, customers pay a recurring fee to access a product or service. This model is popular in the software and entertainment industries, such as Netflix or Adobe Creative Cloud. Subscription models provide businesses with a predictable revenue stream and foster customer loyalty.
Freemium Model:
The freemium model offers basic products or services for free while charging for premium features. Companies like Spotify and Dropbox use this model to attract a large user base and convert some of them into paying customers. This model relies on a clear upgrade path and compelling premium features to drive revenue.
E-commerce Model:
The e-commerce model involves selling products or services online. Businesses using this model, like Amazon or Etsy, can reach a global audience and operate without the overhead of physical stores. The e-commerce model focuses on efficient distribution channels and customer experience.
Franchise Model:
In the franchise model, a business owner (franchisee) buys the rights to operate a business under an established brand (franchisor). Fast-food chains like McDonald’s or retail stores like 7-Eleven use this model. Franchises benefit from brand recognition, established business practices, and ongoing support from the franchisor.
The Razor Blade Model:
This a business model that we discuss in The Tradesman's MBA. It describes a company that offers a primary product at a low price or even at a loss (the "razor") and then makes profits by selling complementary, high-margin consumable products or services (the "blades"). This model leverages the initial purchase of the primary product to lock in customers and drive continued sales of the consumables.If you've ever had to buy replacement ink for your printer, you've seen the 'razor blade' model in practice.
How Do I Choose the Right Business Model?
Here’s how to choose the best model for a given business type:
Subscription Model: Ideal for businesses offering ongoing value, such as fitness programs, digital content, or software services. If a business owner can provide a service that customers need regularly, the subscription model can create a steady income stream.
Freemium Model: Best suited for businesses with a scalable digital product or service, like apps or online tools. This model is effective for startups looking to build a large user base quickly, with the potential to convert a portion of those users into paying customers.
E-commerce Model: Perfect for businesses that sell physical products and want to reach a wide audience without the need for a physical storefront. Entrepreneurs should consider this model if they can manage logistics efficiently and provide a seamless online shopping experience.
Franchise Model: A good choice for those who prefer to minimize risk by using a proven business model provided to them. This model is suitable for entrepreneurs who want to leverage an established brand’s reputation and support systems to reduce startup challenges.
Why Bother? Is Documenting My Business Model Worth It?
1. Clarity and Focus
Documenting the various components of a business model provides you clarity and focus. When you outline each element — such as the value proposition, customer segments, and key activities — you gain a better understanding of how each part of the business fits together and contributes to the overall strategy.
More important tha that, however, is that it also allows you to identify any gaps or inconsistencies in the business that may need to be addressed.
2. Strategic Decision-Making
Documenting how the different components of your business fit together (vendors, customers, distribution channels, etc.) provides you a comprehensive overview of the business’s operations. This is very similar to what we in the Six Sigma world call a Value Stream.
When you examine the different components of your business, you can make informed decisions about potential changes, such as targeting new customer segments, adjusting pricing models, or developing new products or services.
3. Communication and Alignment with Stakeholders
A documented business model serves as a valuable communication tool for engaging with stakeholders, such as investors, partners, and employees. It provides a clear and concise representation of how the business operates and generates value, making it easier to explain the business’s strategy and vision to others. This can be especially powerful when depicted as a graphic.
This transparency helps build trust and credibility with external stakeholders, such as investors, who need to understand the business model to assess the potential for success and profitability.
While not a hard and fast rule that every business must document their business model, I can tell you that when you include it as part of your Business Plan, point number 3 above becomes much more important and much more powerful.
To Your Success,
R. Altomare Founder, BreathEasy Business Management and Consulting
The Shameless Plug
If you'd like some assistance with laying the foundation of your business, please don't hesitate to reach out for a free consult. Together, we can transform your idea into a well-documented plan of action which will give you the confidence to move forward with your idea and be ready to present to investors.
And in case you hadn't heard, BreathEasy also has a book available. It's called The Tradesman's MBA. I wrote this book for the entreprenuer who has ideas for a new business, but lacks the business knowledge to make it successful. The book is jam packed across nearly 300 pages of every conceivable concept, explained in plain language for the new and existing business owner alike. It contains real world examples, thorough explanations and assumes NO KNOWLEDGE of business. This is written for the entrepreneur who knows he lacks information and is intent on filling that gap.
Topics include:
Business Planning and Strategy
Sales & Marketing
Inventory and Project Management
Finance and Accounting
You can order the book at the link below:
Good Luck!
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