Chapter 3 – Business Models
After completing this chapter, you will be able to
- Describe what a business model is
- Analyze existing and proposed businesses to determine what business models they are applying and what business models they plan to apply
- Develop and analyze alternative business models for new entrepreneurial ventures
In this chapter the concept of the business model is introduced. One concept of the business model in particular, the Business Model Canvas, is explored as a way to conceptualize and categorize elements of a business model.
Figure 5 – Business Model (Illustration by Lee A. Swanson)
What are Business Models?
Magretta (2002) described business models as “stories that explain how enterprises work” (p. 87) and Osterwalder, Pigneur, and Clark (2010) noted that they reveal “the rationale of how an organization creates, delivers, and captures value” (p. 14). Chatterjee (2013) said that “A business is about selling what you make for a profit. A business model is a configuration (activity systems) of what the business does (activities) and what it invests in (resources) based on the logic that drives the profits for a specific business” (p. 97).
Osterwalder et al. (2010) said that a start-up is something quite different than an ongoing venture. A start-up should not be viewed as a smaller version of a company because it requires very different skills to start up a company than it does to operate one. A start-up that is still a start-up after some time has passed—maybe after a couple of years for some kinds of start-ups—is actually a failed enterprise since it hasn’t converted into an ongoing venture. Entrepreneurs who develop a business model for their ventures that deliver value to the targeted customers and to the entrepreneur stand a better chance of converting their start-up into an ongoing venture.
The Business Model Canvas
The business model canvas is made up of nine parts that, together, describe the business model (see Figure 6).
Figure 6 – Business Model Canvas from https://strategyzer.com/ (Designed by: Strategyzer AG, strategyzer.com, Creative Commons Attribution-Share Alike 3.0 Unported License)
The following elements of the Business Model Canvas were taken, with permission, from http://www.businessmodelgeneration.com.
- Key partners
- Who are our key partners?
- Who are our key suppliers?
- Which key resources are we acquiring from partners?
- Which key activities do partners perform?
- Motivations for partnerships: optimization and economy; reduction of risk and uncertainty; acquisition of particular resources and activities
- Key activities
- What key activities do our value propositions require?
- Our distribution channels?
- Customer relationships?
- Revenue streams?
- Categories: production; problem solving; platform/network
- Key resources
- What key resources do our value propositions require?
- Our distribution channels?
- Customer relationships?
- Revenue streams?
- Types of resources: physical; intellectual (brand patents, copyrights, data); human; financial
- Value propositions
- What value do we deliver to the customer?
- Which one of our customer’s problems are we helping to solve?
- What bundles of products and services are we offering to each customer segment?
- Which customer needs are we satisfying?
- Characteristics: newness; performance; customization; “getting the job done”; design; brand/status; price; cost reduction; risk reduction; accessibility; convenience/usability
- Customer relationships
- What type of relationship does each of our customer segments expect us to establish and maintain with them?
- Which ones have we established?
- How are they integrated with the rest of our business model?
- How costly are they?
- Examples: personal assistance; dedicated personal assistance; self-service; automated services; communities; co-creation
- Customer segments
- For whom are we creating value?
- Who are our most important customers?
- Mass market; niche market; segmented; diversified; multi-sided platform
- Through which channels do our customer segments want to be reached?
- How are we reaching them now?
- How are our channels integrated?
- Which ones work best?
- Which ones are most cost-efficient?
- How are we integrating them with customer routines?
- Channel phases:
- awareness – How do we raise awareness about our company’s products and services?
- evaluation – How do we help customers evaluate our organization’s value proposition?
- purchase – How do we allow customers to purchase specific products and services?
- delivery – How do we deliver a value proposition to customers?
- after sales – How do we provide post-purchase customer support?
- Revenue streams
- For what value are our customers really willing to pay?
- For what do they currently pay?
- How are they currently paying?
- How would they prefer to pay?
- How much does each revenue stream contribute to overall revenues?
- Types: asset sale; usage fee; subscription fees; lending/renting/leasing; licensing; brokerage fees; advertising
- Fixed pricing: list price; product feature dependent; customer segment dependent; volume dependent
- Dynamic pricing: negotiation (bargaining); yield management; real-time-market
- Cost structure
- What are the most important costs inherent in our business model?
- Which key resources are most expensive?
- Which key activities are most expensive?
- Is our business more cost driven (leanest cost structure, low price value proposition, maximum automation, extensive outsourcing) or value driven (focused on value creation, premium value proposition)?
- Sample characteristics: fixed costs (salaries, rents, utilities); variable costs; economies of scale; economies of scope
The idea is to keep adding descriptions or plans to the nine components to create the initial business model and then to actually do the start-up activities and replace the initial assumptions in each of the nine parts with newer and better information or plans and let the business model evolve. This model is partly based on the idea that the owner should be the one interacting with potential customers so they fully understands what these potential customers want. These interactions should not only be done by hired sales people, at least until the business model has evolved into one that works, because this evolution can only happen when the venture owner is completely engaged with the potential customers and the other business operations (Osterwalder et al., 2010).
A business plan shouldn’t be created until the above has been done because you need to know what your business model is before you can really create a business plan (Osterwalder et al., 2010). Thus, the Business Model Canvas is best suited to technology-based and other types of companies that can be started and operated in some way and later converted into an ongoing venture. By starting operations and making adjustments as you go along, you are actually doing a form of market research that can be compiled into a full business plan when one is needed.
According to Osterwalder et al. (2010), the things we typically teach people in business school are geared to helping people survive in larger, ongoing businesses. What is taught—including organizational structures, reporting lines, managing sales teams, advertising, and similar topics—is not designed to help students understand how a start-up works and how to deal with the volatile nature of new ventures. The Business Model Canvas tool is meant to help us understand start-ups better.
The Business Model Canvas tool is intended to be applied when business operations can be started on a small scale and adjustments can be made continually until the evolving business model works in real life. This contrasts the more traditional approach of pre-planning everything, going through the set-up and start-up processes, and ending up with a business venture that opens for business one day without having proven at all that the business model it is founded upon will even work. These traditional start-ups sometimes flounder along as the owners find that their plans are not quite working out and they try to make adjustments on the fly. It can be difficult to adjust, though, because the processes are already set up. For example, sales teams might be in the field trying to make sales and blaming the product developers for the difficulty they are having, and the product developers might be blaming the sales teams for not being able to sell the product properly. The real issue might be that the company simply isn’t meeting customers’ needs and they don’t have any good mechanism for detecting, understanding, and fixing this problem.
This chapter described business models and presented the Business Model Canvas as a tool that entrepreneurs can use to develop and define their own business models.