Introduction
What is a Business Model? How do we know which Business Model is best for our business? What all Business Models are there?
We often hear about companies that have gone out of business because they didn’t adapt their business model. Kodak is one of the most famous examples:
Kodak was the leading manufacturer of cameras in the world, but its management did not believe in digital technology and believed that customers would appreciate analogue more. However, people discovered that digital photography is faster, easier to use, allows for easy storage and viewing of images, and at a lower price – which turned out to be a big flop for Kodak. The consequences were so severe that they had to lay off a large number of workers and in the end they literally destroyed the factory in Rochester with explosives.
While Kodak was passive, other companies seized the opportunity that the new technology brought to redefine their value proposition and change their business model.
However, the business model implies much more than the mere adoption of new technology. The business model describes how and what the company must do in order to create and sell value using that new technology.
What is a business model?
A business model describes who and how a business creates and charges value.
To understand its business model, a company must answer these four questions. As people change their expectations over time, a company must be willing to periodically revise its responses and adapt to the changes. Consider how leaders of different industries have alternated over time due to the changing business model:
| 20 years ago | Today | What’s changed? |
|---|---|---|
| Wallmart was the largest retailer in the world with 3,500 physical stores. | Amazon is the largest retailer in the world , without a single store. | Customers today enjoy the benefits of online stores that offer them fast delivery and a wide range of offers. Instead of wasting time waiting in line and looking for parking, they today buy online, and the goods are delivered in the shortest possible time. |
| Blockbuster Video was the largest film publishing company with 9,000 stores. | Netflix is the largest movie publishing company, with no physical store. | Customers today are looking for flexibility to be able to enjoy video content anywhere, anytime, while also requiring professional help during the selection process – which makes recommendations extremely important. |
| AT&T was the largest communications company with billions of dollars worth of network infrastructure. | Skype is the largest communications company and does not have a network infrastructure. | Customers today value free internet calls that provide the ability to chat over audio and video signals without any restrictions. |
| Natuzzi was the largest furniture manufacturer in the world to deliver furniture for free. | IKEA is the largest furniture manufacturer where customers choose, transfer and assemble furniture. | Customers today appreciate a wide range of products at an affordable price, even if it is necessary to transport and assemble furniture on their own. |
Customer expectations have changed over time, and so has the way companies create and charge for value. The way the company does this is described by the Business Model.
The University of St. Gallen has devised perhaps the simplest way to depict a business model that is explained in detail in the book Business Model Navigator. In this book, the business model defines WHO your customers are, WHAT you sell, HOW you produce your offering, and WHY your business is profitable:
- “Who” – To answer this question, a company must define one or more segments of the target market to which it will create and charge value.
- “What?” – By answering this question, the company defines its value proposition and describes how it takes care of the needs of its customers.
- “How?” – Here it is necessary to define different processes and activities, but also the resources needed to create and deliver value.
- “Why?” – Here the company defines the costs necessary to create value, but also why and how much the customer would be willing to pay for it.
According to the authors of this methodology, most of the “new” business models are not actually new, but are based on 60 established patterns. Companies today are not inventing new business models, but are looking for ways to incorporate some of the existing models into their business and adapt them to their needs.
A business model is a specific “who-what-how-why” configuration that has proven successful.
Let’s look at an example of such a business model in the following section.
Business Model “Razor and Blade”
The main concept behind the “Razor and Razor” form is to offer the basic product to customers (Who?) at cheap prices or even for free, and then to sell the consumables required for its use at high margins (What? Why?). To ensure that customers remain tied to the original company, it is necessary to prevent competitors from copying that approach by registering a patent (How?).
For the first time, this model was used in the razor industry, from where it got its name. Gillette has successfully implemented this business model by giving free razors to customers and then selling the matching razors at high margins.
In order for this model to be successfully applied, the basic product must be cheap or free, and the consumables necessary for its use are charged at high margins.
Here are some examples of this business model:
- Hewlett-Packard took advantage of this model in the printing industry, offering cheap printers and selling expensive cartridges.
- Nestle applies this model to The Nespresso product. Nespresso machines are available at affordable prices, while capsules are five times more expensive than regular ground coffee.
- Apple offers iTunes software for free and then charges for individual songs at high margins.
The company is not limited to one business model, but can apply several of them at the same time.
Consider an example of Apple’s iTunes:
Although it successfully makes money through the “Razor and Balde” model, Apple also makes money on the same product through the “Subscriptions” model. If you subscribe to Apple Music, you get access to your entire music library.
Successful companies manage to apply as many business models as possible because it allows them to create and sell value in NEW WAYS.
For example, Amazon successfully implements 11 business models simultaneously.
For a full list of business models, see the Business Model Navigator website.
The “who-what-how-why” methodology offers a simple understanding of the model, but does not provide enough details about its functioning. To make it easier for a company to understand for whom and how it creates value, and then how it charges it, it can use a tool called Business Model Canvas.
Business Model Canvas
The Business Model canvas was conceived by Alexander Osterwalder and described in his famous book Business Model Generation.
The business model canvas answers the questions to whom and how we create and charge value through the analysis of the following business elements:
- Customer Segments – Defines one or more customer segments that a business serves,
- Value Proposition – Describes a set of products and services that create value for a specific customer segment.
- Channels – Describes how a company interacts with its customer segments and reaches out to them in order to deliver a value quote,
- Customer Relations – Describes the types of relationships that the company establishes with certain customer segments,
- Revenue streams – Represents the revenue generated by the company from each customer segment,
- Key Activities – Describes the most important things a company needs to do to make its business model work.
- Key Resources – Describes the most important assets (in the form of people, tools, materials and knowledge) needed to successfully perform key activities,
- Key Partnerships Describes the network of suppliers and partners that enable the business model to work and
- Cost Structure – Describes all the costs required for the operation of the business model.
Here’s what Amazon E-commerce business model looks like:
From this we can conclude that Amazon’s E-Commerce Business Model looks like this:
Amazon E-Commerce business uses the “Marketplace” and “Subscription” business models to serve Buyers and Sellers. Amazon offers its customers low prices, fast delivery and a wide range of products and services – while offering its sellers a platform where they can advertise and sell those products. Products arrive at the customer’s address in record time, and sellers do not have to worry about delivery. Amazon achieves this through a superior website and mobile application through which trade is carried out. Also, Amazon offers an exceptional Delivery Network that solves all logistics problems for its sellers. Buyers and Sellers use online tools to self-select and purchase the desired product, and Amazon uses data from previous transactions to provide customers with personalized offers. To maintain its value proposition, Amazon is constantly working to improve its portfolio, its processes, services and infrastructure. He does not do this all by himself, but achieves it with the help of partners who play the role of suppliers, deliverers, sellers and IT vendors. Amazon maintains its competitive advantage by investing in technology for personalization and automation of processes, which requires experts in the field of IT and logistics as well as standard functional teams of a business (HR, Operations, Finance, Legal Department, etc.). Amazon’s main costs are sales (58%) and shipping (16%). Online stores ($222 billion) and Amazon Marketplace ($103 billion) represent the largest source of revenue.
The Business Model Canvas allows us to look at our business from a “bird’s eye view” and to conclude what is crucial for its successful functioning.
Now let’s look at what each of these elements describes.
Customer Segments
A company can divide customers into different segments according to their common needs, behaviors, or other attributes. The Customer Segment element represents the groups of people or organizations that a company wants to reach and provide services to. A business model can define one or more customer segments, so a company must make a conscious decision about which markets to serve and which will not.
Clients are usually grouped into segments due to different specific needs, which require a appropriate value proposition, channel type, or relationship level.
The business model can be focused on:
- Mass Market – Business models focused on mass markets do not take into account differences between consumer segments.
- Niche Market – Business models intended for niche markets provide a specific service for specialized consumer segments.
- Segmented Market –Business models can distinguish market segments with slightly different needs. An example can be found in the automotive industry where the same manufacturer can offer a basic, advanced, but also luxury model to different segments of customers.
- Diversified Market –The business can also serve completely unrelated customer segments in different industries. Amazon in 2006. In 2001, Amazon decided to expand its E-Commerce operations by selling services “on the Cloud”, which enabled the servicing of completely different segments of customers.
- Two-sided Market –Some companies, such as Google and Facebook, provide services to users of their platform free of charge, while companies charge for user-centered advertising. These companies typically serve two or more interconnected segments of consumers.
Value Proposition
A value proposition is a combination of products or services addressing the specific needs of a particular customer segment. Value Proposition offers a solution to problems and customer needs, which is one of the main reasons why they turn to one company instead of another. Values can be quantitative (e.g ., price, speed of service) or qualitative (e.g . design, user experience).
Value comes in 12 basic forms, and for a detailed description of what makes the offer worthwhile, see “What is Value?” (Sections: “Forms of Value” and “What Do Customers Value in Our Offer?”).
Channels
Companies use communication, sales and distribution channels to advertise, sell and deliver their value offerings to customers.
Channels describe how a company interacts with and reaches out to certain segments of customers. These channels represent a point of contact with customers, providing them with an important service or product experience.
Channels are used to:
- Increased customer awareness of the company’s products and services,
- Providing access to products and services,
- It delivers value and
- Support after purchase.
Customer Relations
The company must identify the type of relationship it wants to establish with its customer segments. Relationships can vary from personal to automated. The main goals of these relationships are to acquire new customers, retain existing ones and increase sales.
We can distinguish several categories of customer relationships:
- Personal Service – This relationship is based on human interaction so that the customer has the opportunity to talk to the right representative of the company through whom he can get help with the purchase.
- Self-service – In this type of relationship, the company does not maintain a direct relationship with customers. Instead, the company provides all the necessary means so that consumers can make purchases independently.
- Automated Service – This type of relationship links user self-service to automated procedures. With automated service, interaction with the user is achieved through an adequate technological solution.
Sources of Income
Revenue streams represent the money that a company generates from each customer segment.
To achieve success, a company must explore the value for which each segment is willing to pay. This process allows you to generate one or more revenue streams from each segment. Each of these streams can have different pricing mechanisms.
The business model generally consists of two types of income: one-off and recurring.
Customers can charge for products or services through:
- The sale of ownership rights to a physical product,
- The more services are used, the more the customer pays,
- Subscription (sale of continuous access to the service),
- Borrowing (rental of products for a certain period of time),
- Licensing or
- Advertising.
Key Activities
This element helps a company determine the most important things a company must do for its business model to work. Some of these things will be done by the company itself, and some will be delegated to its key partners.
Companies are engaged in numerous activities to operate successfully. As can be concluded from the Business Model Canvas, the most important of them are: creating and delivering value, advertising on the market, maintaining relationships with clients and generating revenue.
Key Resources
The “Key Resources” element helps the company define who will perform key activities.
With key resources, the company identifies the most important means for the functioning of the business model. They are used to create value supply, reach the market, maintain relationships with consumer segments, and generate revenue.
These resources can be:
- Physical (drives, vehicles, buildings, tools, systems)
- Financial (capital, loans, funds)
- Intellectual (brand, patents, copyright) or
- Human.
Key Partnerships
Companies often delegate activities to their partners who can perform them better, faster or cheaper. With this element, the company defines a network of suppliers and partners who are key to the successful functioning of the business model. Partnerships are formed for many reasons, and they become the basis of many business models. Companies create alliances to optimize their business models, reduce risk, or get the necessary resources.
Cost Structure
This structure describes each cost that occurs when executing a business model. Within this element, the company describes the most important expenses related to the business. The functioning of the business model requires some effort, which is reflected in the form of costs. After defining key resources, activities and partnerships, these costs can be calculated relatively easily. Regardless of the business model, the company should always try to reduce costs.
For some companies, the success of the whole model depends on providing the cheapest service. For others, the quality of services, exclusivity or uniqueness of the offer is important where customers are willing to pay a higher price (so the costs are not crucial).
Conclusion
A business model describes to whom and how a business creates and sells value. Business models are often analyzed in too much detail, and thus the big picture is lost. Therefore, it is a good idea to visualize the business model “from a bird’s eye view”, and we can use tools such as Business Model Canvas for this. Using innovative business models, start-ups today challenge the “old guard” and find new ways to win more market share. To innovate your company’s business model, you don’t have to reinvent the wheel — most business models are based on already established patterns. Business models are not limited to one industry, but can be applied in different environments. The key to business model innovation is to find a way to apply a business model in a context that has not been previously used.