Every business has a specific way of organizing its operations and generating revenue. It’s not just a matter of running a store or a website. It’s about how the company pays for itself and its offerings support its overall business goal. This is where the concept of a business model comes into play. But the question several people have on their mind is, what is a business model?
A business model is the set of business operations that support a company’s core purpose. It’s how a company earns money and how to distribute money.
In this article, we’ll look at what is a business model and how it can help you improve your company’s efficiency and profitability.
What Is a Business Model?
A business model is a formula that outlines how your company generates revenue and what methods it uses to break even. This can be as simple as opening a store and selling inventory or something more complex like running a website where you charge for advertising space.
The way a company can make money with its product and customer base in a specific market. It explains four things:
- What the product or service will be
- How does it plan on marketing that product or service
- What kind of expenses it can expect for doing so
- How it hopes to turn a profit.
Because there are many types of businesses out there- business models are constantly changing. There is no one size fits all model that applies to every business.
A business model is not just about generating money for the company. It also includes allocating profits among different stakeholders in the company – shareholders, employees, etc. Let’s learn more about our topic – what is a business model?
Essential Components of a Business Model
The essential components of a business model are the same and always have been, but they can still be varied in form or function.
A few examples include a definition, with a brief example showing that all models consist of similar elements: a unique value proposition, viable target market, and competitive advantage. Without these three aspects, the company cannot generate revenue by any means outside ownership (unless it’s an investment opportunity).
What is a business model and what goes into creating one? Business models are also about more than just income; you need to consider production costs and other factors. Here are the ten components you’ll want to keep in mind:
- A Value Proposition is a feature that makes your product attractive to customers.
- The Target Market is a specific group of people interested in the product.
- A Competitive Advantage is a unique feature of your product or service that competitors can’t easily copy.
- A Cost Structure lists your fixed and variable expenses, how they affect pricing, and what you can do to minimize them.
- Key Metrics are the ways your company measures success.
- Revenue Streams are the different ways your company can make money.
- The Problem and Solution section of your sales pitch should state your target customer’s pain points and how you intend to meet them.
- The Profit Margin for your business is the amount by which revenue exceeds business costs. These are all of the essentials that make up a typical business model, and they will likely change as your needs mature.
- Resources are physical, financial, and intellectual assets that your company has access to.
- Revenue Models are frameworks that identify viable income sources to pursue.
Writing a business plan helps you identify what is a business model so it can make ideas more evident. Once identified, the model will provide vision and direction for your business idea. While its focus is on operations, the model won’t solidify one’s strategy in stone- as progress occurs, learners may change and adapt their strategy based on what they discover.
What are the Types of Business Model?
We now know what is a business model, so let’s break down the various types of business models. As we’ve mentioned before, there are many different business models. These include:
- Product to a service model
The product-to-service business model works by allowing customers to purchase a result rather than the equipment that delivers it. Businesses in this category sell their products for a one-time fee. This business model is also known as the product life cycle.
Suppose you are the owner of a company that makes scooters and needs two pieces of metal welded together. You might ask another company to do this instead, saving on your investment in welding machinery for now but knowing you’ll be able to output more later if customer demand increases.
Examples: Zipcar, Uber, Lyft, and LIME.
- Manufacturing-based model
These businesses focus on manufacturing and selling physical products. The most traditional business model is the “manufacturer” one when a company converts raw materials into a product.
Dell Computers and Hewlett-Packard are examples of manufacturers who use parts manufactured by other companies to make their finished products.
Examples: Intel, Magic Bullet, Black + Decker, and LG Electronics.
- Franchise model
The franchise model is perhaps the most well-known type of business model. It’s become so recognizable that we can see them daily as franchises are often everywhere. What does a franchise involve, exactly?
A typical franchiser will purchase an established blueprint and reproduce it for their use; this plan goes by the name of a “franchise.”
The original owner helps finance and manage the new operation to make sure that everything runs smoothly — which includes paying a percentage of any profits made from the business back to their franchisers periodically.
Examples: Starbucks, Domino’s, Subway, McDonald’s, and the UPS Store.
- Distribution Model:
Distributors are the middlemen who take a company’s manufactured goods to market. For example, when Hershey produces and packages its chocolate, distributors are responsible for transporting it from manufacturing facilities to retailers.
To profit from their investment in these products, they buy them in bulk at wholesale prices and sell them at retail prices higher than what manufacturers offer.
Examples: HD Supply, Avent, Cheney Brothers, and ABC Supply Co.
- Crowdsourcing Based Model:
Crowdsourcing refers to receiving opinions, information, and work from many different people. This allows companies to tap into a vast talent network without in-house employees.
One example is an app that encourages drivers to report accidents in real-time to other users on this app.
Examples: Wikipedia, YouTube, IMDB, and Indiegogo.
6. Affiliate Model:
The affiliate business model is similar to the advertising business model in some ways but has distinct differences. This model is commonly used online and involves embedding links in content rather than using explicit visual ads.
An instance of this is when you have a book review website, and you can embed affiliate links to Amazon in your reviews. This way, people can buy the book you reviewed, and Amazon will pay you a commission for every sale you refer to them.
Examples: TheWireCutter.com and TopTenReviews.com
7. Brokerage Model:
Brokerage businesses act as intermediaries between buyers and sellers to aid in completing transactions. They receive a fee for their services from either the buyer, seller, or both parties involved.
Real estate agencies are one of the most popular brokerage businesses. Still, several other types of brokerages, like freight brokers and brokers, assist construction companies in locating buyers for extracted soil from new foundations.
Examples: RoadRunner Transportation Systems and ReMax
8. Freemium Model:
A freemium business model involves providing a portion of your product or service for free while charging for premium features or services. It differs from a free trial, where customers only have limited access to the product or service for a set time.
With freemium, customers can use the basic features for free with no restrictions but have to pay for more advanced functionality.
Examples: Evernote, LinkedIn, and MailChimp
9. Leasing Model:
Leasing and fractionalization may seem alike, but they are two different concepts. Fractionalization involves selling indefinite access to a portion of something, while leasing is more like renting. When a lease term ends, the customer must return the rented product.
Leasing is frequently used for expensive items that customers cannot afford to buy outright but can rent for a period.
Examples: DirectCapital and Cars
10. Pay-as-you-go Model:
The pay-as-you-go model is a billing method where customers are charged for their actual usage at the end of a billing period instead of pre-purchasing a certain amount of something like electricity or cell phone minutes.
This type of billing is commonly used in home utilities and has also been applied to other products like printer ink.
Examples: HP Instant Ink and Water Companies
11. Razor Blade Model:
The razor blade business model is the strategy of selling a sturdy product at a lower price to boost the sales of a disposable part with a higher profit margin.
As a result, razor companies tend to provide razor handles at a nominal cost, anticipating that the customers will purchase a significant quantity of blades in the future. This approach aims to create a loyal customer base that will continue to make regular purchases over an extended period.
Examples: Xbox, Amazon’s Kindle, Gillette, and Inkjet printers
12. Subscription Model:
Subscription-based business models have gained popularity in recent times. Under this model, customers must pay a recurring fee to avail of a service. Although this model has been prevalent in print media for a while, it has expanded to online services, software, and service industries.
Examples: Netflix, Amazon Prime, and Salesforce
13. Low-touch Model:
Companies can decrease their prices by offering fewer services, which is known as a low-touch business model. Budget airlines and furniture sellers like IKEA are prime examples of this model. In such cases, customers may have to buy extra services or take some actions on their own to keep expenses in check.
Examples: IKEA and Ryan Air
This will guide you about what is a business model. These business models can be customized or changed based on the specific company or industry- this process is often referred to as creating a disruptive or novel type of business model. Let’s learn more about what is a business model.
How to choose the business model?
Picking the suitable business model for your small business can be challenging, especially with many different options.
However, you should consider some things when deciding what is a business model and which is best for you.
For example: Picking a suitable business model depends entirely on what type of scope your company has and how much it will cost them to succeed. Start by narrowing down choices based on the kind of idea that you want, and then ask yourself these questions:
- What does my small business need?
- What is my timeline like?
- Am I able to handle all aspects myself, or do I need assistance?
- Do I have enough money upfront, or am I looking at a monthly budget if/when starting this new enterprise?
- How will I generate revenue?
- Who’s my target customer?
- What startup costs am I looking at, and what expenses are fixed/variable cost considerations.
You should be able to answer these questions. In addition, it may be helpful to research other businesses that are similar to yours (especially competitors) and see how they’ve structured their operations.
This information will inform you what is a business model and offer possible avenues to differentiate your own business from others.
What Are the Benefits of Using a Business Model?
Investors want to know that the company they’re investing in has a clear idea of what is a business model and, what it intends to offer, and how those offerings will make money.
A business model is a helpful tool for understanding how a company operates, what it needs to succeed, and how management can allocate resources. A transparent business model also helps you get funding.
A business model is also essential if you’re looking for outside help. For example, if you need to hire an app developer or web designer, it helps to what is a business model outlined so you can clearly explain what your vision is before you start talking about money.
A business model usually includes everything related to creating, producing, and selling a product.
For instance: information about the target audience and distribution of goods, how consumers will pay for these products or services (e.g., by presenting their value proposition), and costs involved in producing that good or service as well, as it includes sources of financing.
A good company marketing strategy often includes what differentiates the company from its competitors, possible partnerships within this industry, an analysis of what competing companies offer – even if it’s just brief, and projections on revenues/expenses at the end. Hopefully, now you know what is a business model and how to choose one.
The Bottom Line
By understanding what is a business model, you can identify the best way to achieve your goals. You can then use your business model as a framework to help you make decisions and reach your goals faster.
Even though mapping out what is a business model may feel overwhelming, especially when it’s just one piece of planning and launching your business, you need to remember that there are ways to simplify it.
You can think of a basic business model as a plan that shows how you’ll make money. Plus, by putting time and effort into outlining your business model now (even if only in the most general terms), you’re taking the necessary steps towards success in the future.
Hey everyone, after reading this article, I’m getting a better understanding of what a business model is and why it’s so important. But I’m curious, how do you figure out which business model is the right fit for your specific business idea? Any tips or personal experiences you could share? I’m new to all of this, and any advice from seasoned entrepreneurs would be really valuable. Thanks a bunch!