Maria Peloponisiou~ 5 min Reading time | 20. Mar 2020
Your business model is the fundamental structure of your business—all of the elements that work together to make you money. Many people decide on business models intuitively before they are even aware, they’ve done so. But which business model you choose can end up being what makes or breaks your business, so whether you’re just starting out or you’ve been in business for a while, taking some time to consciously assess your business model is a great way to help you stay profitable.
What is a Business Model?
Business models are kind of like car engines—although each engine propels the car forward, each type of engine is unique in its design. While all business models are designed to make the business financially sustainable or profitable, they vary widely depending on the business. Business models describe the way you make money: the process, target market, purpose, structures, and business culture that keeps the business moving.
While there are a wide variety of business models to choose from, they can fall into broad categories. Sangeet Paul Choudary, an expert on platform economics, has theorized that business models fall into two general categories:
Pipes are business models that operate using a conventional approach: the business owner develops a product or service, markets it to the public or other businesses, and generates profits through its sale.
Platforms are a more complex and recent phenomenon and are most often found online. Platforms build an interconnected network of consumers and creators, and make money more indirectly, through things like advertising and subscriptions.
Why Business Models Matter
When you’re in a room pitching to investors, they’ll often want to see your financial reports in the context of your business models. Why? They know that your business model will have an important impact on your bottom line and scalability. For example, if you’re starting a retail store, you’ll generally have a lot of money tied up in rent, stock, and employees before you start turning a profit, and opening multiple locations will take a lot of time and effort. However, if you’re starting a dropshipping store online, your overhead costs will likely be much lower, and your business will have the potential to scale more quickly depending on the market.
Examples of Business Models
A common type of business model in the fast-food industry is the franchise model. In this model, a business owner sells access to their trademarks and process to a franchisee, so that the franchisee can open a store and run it. The franchisee usually pays a startup fee and additional annual fees but collects most of the profit at the location they run. Franchisees have the advantage of selling under an established brand that has already earned a public image, and franchisors make money off royalties and fees without having to manage the day-to-day operations of the store. Some well-known franchises are McDonald’s, Subway, and Wendy’s.
Direct Sales Model
Another type of business model is the direct sales model, where a company sells products or services without a fixed location. They hire independent contractors to sell the products to consumers directly, whether through door-to-door sales, over the phone, or online. Direct sellers sometimes also show the products in their homes to small groups of people. Avon is one of the most famous examples of this business type.
How to Establish the Right Business Model
Usually, people just starting out in business will choose an existing business model and modify it—this works if your business type is similar to that of other businesses. For example, someone opening a coffee shop might base their business model on other coffee shops but have additional events night once a week that brings in an alternate revenue stream.
Someone creating a new and innovative tech platform might have a more creative business model, where the technology is monetized in a unique way. Starting from scratch has the potential to be very lucrative, but also has more pitfalls, since you’re entering into unknown territory. Over the years, established frameworks for developing business models have evolved from the tech industry to become common tools for business model innovation.
For example, the Business Model Canvas divides a business into nine components which must fit together. Initially created by Alexander Osterwalder, the Business Model Canvas is a helpful way to summarize how the different elements of your business will work together. These are:
Key partners: external companies like suppliers that you’ll need to do business with
Key activities: these are the activities that help your business accumulate wealth
Key resources: the resources you’ll need to make your business model work
Value propositions: what makes your customers engage in business with you; what value your products or services bring to them
Customer relationships: what types of relationships you’ll need to maintain with your customers
Channels: how you’ll sell to customers; for example, they can be physical channels such as storefronts, or digital channels such as an online store
Customer segments: the demographics of the individuals or businesses you’re selling to
Cost structure: all the liabilities and expenses that your business will generate
Revenue streams: how you’ll generate revenue. This includes things like profit margin, your share of the market, and ways
Going through each of these key components can help you solidify how your business processes will all work together, which can be particularly beneficial if your business model is complex or unusual.
Even after you’ve developed your business model, it’s a good idea to revisit it periodically, since all business models are based on markets that change over time. Once you’ve developed a business model, test it on a small segment of your target market. Make sure your product or service can deliver on its claims, and that you’ve chosen the right channel to sell it. Talk to industry experts if you need industry-specific advice. Remember that your business model isn’t written in stone. Taking some time to revisit it and revise when necessary will help you maintain the agility you need to make your business thrive over the long term.