Business Plans: Research & Preparation

Building and Refining a Business Model

A business model is a description of how a business makes money. Here's what your business model needs to deliver on in order to ensure the venture is profitable.

By Greg Fisher

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These are some of the questions entrepreneurs or business managers should consider if they want to improve their business performance. Why? They encourage greater focus on the business model.

1. How does your business make money?
   
2. Where does your revenue come from?
   
3. What are your major costs?
   
4. Have you invested enough to ensure you can continue operating in the future?
   
5. What are the critical success factors of your business?
   

What is a business model?

A business model is a short sharp description of how a business makes money; it is an explanation of the profit engine within the business. In order to capture how a business makes money a business model needs to:

• Capture how the business generates revenue
• Identify the major costs incurred in generating revenue
• Describe the investments required to implement and sustain the business into the future
• List the factors that are critical for the success of the business

A business model description can be captured in a few sentences or depicted as a diagram that shows the flow of income and costs.

Why is it useful to think about your business model?

Thinking about your business model can be an excellent source of clarity, focus, innovation and differentiation.

Clarity And Focus

Lack of clarity and focus can erode potentially good business ideas. Too few entrepreneurs and business managers take the time to clarify critical issues such as their target market, what they are going to do to make money, what their major cost drivers are and what they can do to minimise those costs? Because people don’t take the time and effort to address these issues, they operate their business in a haze, making vague decisions and hoping for the best. Managers add on new lines of business without ever really understanding whether it makes sense to diversify.

They see an opportunity and just start exploiting it without really analysing whether it will make a profit. The discipline of defining and articulating your business model will help you streamline your business so that you only engage in activities that positively contribute to the bottom line and assist you in identifying activities that should be discontinued because they are using up resources in an inefficient and unproductive way.

Building and Refining your Business Model

The process of building or refining your business model is a matter of carefully working through and answering these four important questions:

This question forces you to focus on how your business will generate revenue. In thinking about this question it is important to:

• Identify the target customer. Who will buy your products or services? Be specific in identifying your target customers by their demographic profile, where they live, their preferences, and what will trigger their buying decision.
• Be specific about the value you will be providing to the customer. What benefit will they get from the goods or services you are selling to them? The more clear you are about exact value that customers can expect, the easier it will be for you to sell the goods or services. The value that you provide should be communicated in all marketing material that goes out from the company.
• Be clear on the number of revenue streams you will have in your business. Many businesses have more than one revenue stream and there is a different set of customers attached to each revenue stream. For example, a magazine will generate revenue from unit sales and advertising. The customers linked to the unit sales are the readers and the customers linked to the advertising revenue are the companies placing adverts.
• Be specific about price. What do you expect to charge for your product or service? Knowing your expected price point is important so that you can evaluate whether customers perceive that they are getting tangible value at that price point and to evaluate whether you can make a profit selling at your intended price.
• Recognise the timing of expected income from sales. Will you collect revenue before or after the sale? Will the revenue be collected as a once off payment or over a period of time?

How to Fine Tune The Business Model to Increase Revenue:

In order to think about how you can make your business model more innovative from an income generation perspective, consider these questions:

1. Are there people or businesses that could use my goods or services but don’t currently have access to them? Would it be beneficial for me to reach out to such
a group?

Example: One of the major business model innovations in the South African cell phone industry was “pay-as-you-go”. By changing the nature of the offering, South African cell phone companies were able to tap into much larger markets. MTN and Vodacom were global pioneers in the pay-as-you-go cell phone business model and it is one of the reasons that both companies have been so successful.

2. Are there people who are not buying what I offer because of the price point? If I shifted the price point up or down and adjusted my offering could I tap into a whole new market?

Example: Kulula.com radically expanded the market for airline travel in South Africa by dropping the price point for domestic airline tickets. Virgin Active innovatively expanded their offering by creating classic clubs with a premium offering and a higher price point to establish exclusivity for those willing to pay for it. 

3. Is everything you are doing for customers providing them with value? Could you simplify or lessen your offering without impacting your customers’ perception of value?

Example: Outsurance discovered that not everyone valued the services of a broker when buying insurance. People were willing to do the work of a broker themselves if they were given the right information. Outsurance created the highly successful direct model for selling insurance.

4. Are there additional untapped revenue streams that you could exploit?

Example: Vida e Caffe don’t only sell great coffee, they also sell advertising space, creating lucrative additional revenue streams. They produce and sell advertising space in a quarterly magazine called Obrigado that is available in their stores. They also sell advertising space on their take away cup holders and little tags attached to their in-store mugs.

5. Are there ways that you could alter the timing of revenue collection to benefit the business? Most smaller businesses benefit by getting cash in earlier to speed
up cash flow.

Example: Many coffee shops in the USA have store cards. If you buy a store card you are in effect paying for ten cups of coffee in advance. This means that the coffee shop collects cash on their sales a long time before the sale is made and they reward customers for this by reducing the price of a cup of coffee for those who buy on a prepaid card. This practice benefits all parties: the shop has a healthy cash flow, customers don’t need to carry cash and can get their daily fix at a cheaper price. Many larger companies benefit by slowing down the payment process. For example, BMW make more money by financing cars than they do selling them. By slowing down the payment process they make money on the interest that is charged to customers.

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Published 26 October 2009 | Editorial Disclaimer
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