Once upon a time, all business models were relatively similar and relatively simple. You bought low and sold high. The more you could repeat this simple recipe, the richer you would grow. But the world has become more complex and more competitive.
New technologies have opened up many different ways of doing business and most companies are no longer competing just with the business down the road, they are competing with entities from across the globe. In this environment of increased complexity and heightened competition, a firm’s business model has become a critical source of competitive advantage.
The entrepreneurs and managers who have taken the time to understand what a business model is and how to innovate around their own business model have found new sources of profit and growth. By contrast, those who have failed to adapt their business model have found themselves languishing and giving way to their more inventive rivals.
What is a business model? What is business model innovation? How can a business model be a source of competitive advantage? How can refining a business model drive growth and profit within an enterprise?
Let’s look at the concept of a business model and see what tools and insights are available to enable entrepreneurs and managers to innovate with new business model designs. In doing so, we’ll be drawing on the concepts captured in the recently released book Business Model Generation by Alex Osterwalder and Yves Pigneur.
What is a business model?
Quite simply a business model is a description of the rationale of how an organisation creates, delivers and captures value. A business model describes how a company creates an offering, gets it to customers and generates profit from the transaction.
The research of Alex Osterwalder and Yves Pigneur suggests that a complete description of a company’s business model can be broken down into nine elements:
- Value proposition: A clear description of the company’s offering and how it solves problems or creates value for customers.
- Customer segments: The specific group of people that the organisation aims to serve.
- Channels: The means that a company uses to reach its customer segments to communicate with them and to deliver products and services to them.
- Customer relationships: The methods used to maintain relationships with customer segments.
- Revenue streams: The income generation and collection mechanisms in the business.
- Key resources: The most important assets that the company needs to make the other elements of the business model work.
- Key activities: The most important things that a company must do to make its business model work.
- Key partnerships: The network of suppliers and partners that make the business model work.
- Cost structure: The major costs that need to be incurred to sustain the business model.
These nine business model building blocks can be captured in a single diagram called the business model canvas. It sets the value proposition at the centre of the business model as the primary focus area. The customer building blocks (customer segments, channels and relationships) can be found to the right of the value proposition and infrastructure building blocks (resources, activities and partners) to the left.
The finance-based building blocks (revenue and cost structure) can be found on the lower portion of the diagram.
Building & refining a business model
The nine building blocks and the business model canvas are excellent tools (1) for understanding your current business; (2) for refining a business to make it more profitable; and (3) for designing a new business model.
The process of applying the business model canvas to define or refine a business model is relatively simple but extremely powerful.
Gather the people you want to participate in the process. In a business it is useful to get the entire management team involved. Different people bring new perspectives and insights and therefore having a broad base of participants is often an advantage.
Once you have all the participants gathered together, you should present a copy of the business model canvas and explain to people what the different components of the canvas mean.
Map out your firm’s existing business model on the business model canvas (note, if you are designing a business model for a brand new business, this step can be skipped). The mapping of the business model will give all participants in the process a common understanding of the company’s current operations.
Brainstorm ideas for different ways of doing things within the business model. If you’re designing a new business model the focus will be on how you build up the different elements of the business model to create a valuable enterprise.
If you are refining a company’s existing business model then you can work though each of the nine building blocks and ask the following questions:
“How could we do things differently?”
“How can we create more value for customers?”
“How could we be more efficient?”
As you go through the process of brainstorming ideas for each of the nine building blocks be sure to:
- Encourage everyone to participate:
- Keep asking questions
- Record all ideas:
- Don’t judge ideas immediately, write them down and judge them later
- Be visual:
Put the business model canvas up where everyone can see it and record the ideas in such a way that all participants can see them. One useful way to do this is to draw the business model canvas on a very large sheet of paper or project board, stick it on the wall and then use post-it notes and markers to record all the participants’ ideas in the respective blocks.
Identify the good ideas. The challenge is to create a way for the group to decide on the best ones. One way to do this is to give the individuals in the group a pack of adhesive stars and get them to vote on the best ideas. Another way is to get the people to vote on paper if you prefer.
Bring the best ideas together in a coherent business model. To do this you can give each participant a clean business model canvas and get them to create a new business model for the company, using the best ideas generated in the session. Each person can then present their new business model back to the group. From this a new business model can be devised.
Plan for the implementation of the new business model. Create a set of action steps and allocate responsibility for the implementation of the steps. The process described above, or some variation of it, will provide an entrepreneur or manager with a practical, meaningful and productive way to design a new business model.
Examples of innovative emerging business models
To understand how business models are evolving and to get inspiration for designing an innovative new business model, it is worth examining some of the new patterns emerging. Over the past 20 years we have seen a proliferation of these.
Many new business models are built around the Internet, yet it’s not an essential ingredient of business model innovation. Below are some examples of emerging business models as identified by Alex Osterwalder and Yves Pigneur.
Long tail business models
In long tail business models a company sells lower quantities of more types of products to very niche groups of customers. Traditionally business looked to create ‘hit’ products – products that would appeal to the largest segment of mainstream customers.
Because the cost of finding customers and producing and distributing products in many industries has decreased, some businesses have emerged to service small, dispersed groups of customers.
Global example of a long tail business model:
Publishing industry: Lulu.com
Previously the goal of a book publishing company was to find the next best-seller – Harry Potter and the like. Lulu.com, an emerging book publishing business, turned this model on its head. Instead of focusing on best-sellers, they created a platform that enables any amateur author – you, me or the person next door – to publish a book.
They make their money by providing authors with the tools to self-publish and they also provide a platform for people to buy and sell self-published books.
Other examples of companies that employ a long tail business model include CD Baby (music), Springleap (T-shirts) and Netflix (movies).
Additional reading on long tail business models:
The Long Tail: Why the Future of Business is Selling Less of More, by Chris Anderson, 2006.
Multi-sided platforms bring together buyers and sellers. They create a space where people can transact. The platform creates value by facilitating interactions between different groups. A multi-sided platform becomes more and more valuable as more and more people use it.
Local example of multi-sided platform business model:
Real estate sector: Private Property
Private Property has established a platform that brings together buyers and sellers of real estate on the Internet.
By making it easy for sellers (including traditional real estate agents) to load property descriptions, pictures and videos onto their site and by making it easy for sellers to search and save properties, they have created a business model that has transformed the way many people find property to buy or rent.
There are many industries, local and global, that are being transformed by businesses with multi-sided platform business models. Examples include eBay (auctions), Craigslist (classifieds), Apple App Store (software applications), and Google (advertising).
Additional reading on multi-sided platform business models: Strategies for Two-Sided Markets, Harvard Business Review, by Thomas Eisenmann, Geoffrey Parker and Marshall W van Alstyne, 2006.
‘Free’ as a business model
Many businesses are finding it possible to deliver a product or service to a substantial customer segment at no cost; non-paying customers are financed by some other portion of the business.
Because people are naturally attracted to offerings that are free, many businesses find benefit in providing their offering at no cost to generate demand and create interest in what they are doing. They then find ways to get certain customer segments to access additional services and to pay for those services.
Global example of a free business model:
Anyone with friends, family and acquaintances living abroad has probably discovered the magic of Skype. If you and your friend both have an Internet connection you can call each other at absolutely no cost (except for the Internet bandwidth that you might be paying for).
Skype does this to get people to start using the network. The more people that are on Skype the more valuable it becomes for users. As people depend more and more on Skype for their daily communication needs so they discover that there are a whole lot of additional services that are worth paying for.
You can pay to call people directly on their phone or to set up premium services with all sorts of additional features. I started using Skype as a pure free user and I now spend about $10 a month to access additional services. As more and more people follow this trend it will become an incredibly profitable business.
Other examples of businesses that incorporate free into their business model include Dropbox (online storage), Google (search), Youtube (online video), and Facebook (social networking).
Additional reading on free as a business model:
Free: The Future of a Radical Price, Chris Anderson, 2008
Bait & Hook
The bait and hook business model is the practice of luring a customer in with a relatively cheap upfront purchase but then making money off them with more lucrative ongoing servicing. The most famous example of the bait and hook business model is in the razor blade industry.
Gillette will sell you the actual razor for next to nothing but then make huge margins every time you replace the disposable blade.
Local example of the bait and hook business model:
Motor Industry: BMW Financial Services
BMW retailers in South Africa give their customers very good deals on cars but then get them to utilise the BMW Financial Services package as a means to finance the car. They make the real money on the purchase through the ongoing interest payments that you make in paying off your vehicle.
Other examples of the bait and hook business model include: HP (printers and printer cartridges), cellphones (cheap handset but expensive ongoing contracts), Multichoice (pay TV – give away the decoder but charge high monthly fees for customers to get value from the decoder).
These are just a few of the interesting new business models that are emerging to create value for companies. One of the real challenges is that successful business models are often replicated and after being copied too many times, they are no longer valuable.
Gary Hamel said, “…all too often, a successful new business model becomes the business model for companies not creative enough to invent their own.” Most times the first mover – the firm that comes up with the business model that transforms an industry – benefits immensely from their innovation.
A new business model can be a source of competitive advantage for many years – Southwest has maintained its advantage with the low-cost airline model for over three decades and Gillette has done the same with its bait and hook razor blade model for just as long.
The challenge for today’s entrepreneurs and business managers is to be creative enough to invent a business model that is radical so you can attain advantage in your industry for decades to come. Don’t just copy what others have done. Use the tools provided in this article to help you create something that is new, different and transformative. Good luck!
Business model generation source book
Business Model Generation, by Alex Osterwalder and Yves Pigneur, is available from Kalahari.net
Disruptive new business models are emblematic of our generation. Yet they remain poorly understood, even as they transform competitive landscapes across industries. Business Model Generation offers you powerful, simple, tested tools for understanding, designing, reworking, and implementing business models. It’s a practical, inspiring handbook for anyone striving to improve a business model – or craft a new one.
The book will teach you powerful and practical innovation techniques used by leading companies worldwide. You will learn how to systematically understand, design and implement a new business model – or analyse and renovate an old one. Business Model Generation also has a tightly-integrated, visual, lie-flat design that enables immediate hands-on use.
- Seizing the White Space: Business Model Innovation for Growth and Renewal; By Mark W Johnson; Harvard Business Press; 2010
- Open Business Models: How to Thrive in the New Innovation Landscape; By Henry W Chesbrough; Harvard Business Press; 2006
4 Types Of Business Models
There are four main types of business models, see which one suits your business concept.
Different types of business models suit different types of businesses. A business model is the way that a company sells products to its customers. It describes how a business creates, delivers, and captures value.
What type of business model should you adopt?
A business model defines how the enterprise delivers value to customers, gets them to pay for that value, and converts those payments to profit.
There are four basic types of business model that any for-profit business will fall into:
A manufacturer takes raw materials and creates a product, or assembles pre-made components into a product (E.g car manufacturers). A manufacturer may sell its products directly to its customers, or it can outsource sales to another company.
Portia Molefe shared her thoughts about small enterprises and their growth into Africa after interviewing the finalists who stood in line to win the ‘Think Big’ prize of R 1 million to back into their business.
A distributor is any business that purchases products directly from a manufacturer for resale either to retail outlets, or directly to the public. For example, a car dealership would purchase vehicles directly from the manufacturer and sell them to the general public.
A retailer purchases product from a distributor or wholesaler, and then sells those products to the public. A retailer usually has a physical location, but may also be an online retailer such as Amazon or Kalahari.
The new smartphone-centric status quo isn’t such a bad thing for retailers, especially those willing to adapt their strategy. Find out how retailers can accommodate the mobile-obsessed customer.
A franchise can be a manufacturer, distributor or retailer, depending on what type of franchise you purchase. Here the franchisee adopts the business model of that franchise.
Under these four types of business, there are various other ways of structuring your business model.
- A company that integrates a physical and an online presence. An example would be a retailer who allows customers to order products online, but lets them pick up their order at their nearest store.
- A company that deals with customers directly via the internet without engaging an intermediary.
- Direct selling to consumers making use of product demonstrations in the person’s home, for example. There are several cosmetic and jewellery companies that use this model in SA.
- The Freemium business model works by offering a basic Web service or product, for free, while charging a premium for advanced or special features.
- Online auctions, which are held over the internet.
How To Pick The Business Model That Works For You
So, you’ve picked your lane. You’ve decided what you want to do and why you want to do it. You’ve picked something you’re good at. You’re convinced the world needs and values it. You now need to decide how to make money. That’s where business model design comes in.
There are plenty of business model options for the same idea. For example, let’s say your idea is to offer historic tours of Cape Town. You could either do it yourself or hire professional guides to do it. Or you could use mobile technology to provide DIY walking tours. You could charge per tour or you could charge a membership fee. There are so many options. How do you pick the model that works for you?
The Lean Canvas is a great tool for entrepreneurs who are faced with this question. Adapted from The Business Model Canvas, it provides a simple, one page framework for brainstorming possible business models, prioritising where to start, and tracking ongoing learning. It walks the entrepreneur through the business model process logically and ensures the key elements of a successful business are considered.
My co-founders and I have used the Canvas extensively at Simply – for designing our business model, and for communicating it to partners and investors. The only thing you know with certainty when you start a business is that it’s not going to turn out as you expect it to. The Canvas evolves as you go – it was, and continues to be, a very useful guide in our journey.
Recognising an opportunity for disruption
We figured there was an opportunity to do something disruptive in the SA life insurance space. It was clear to us that lots of people were either not covered or getting a rough deal. Guided by the Canvas, we defined our first Customer Segment as adult South Africans, aged between 25 and 45 and earning between R5k and R30k monthly.
We then identified the 3 big Problems – specific to that segment – that needed solving:
- Most of the people in our segment have some form of funeral cover, but very few have life or disability cover.
- The cover they do have is often expensive relative to the benefits provided (i.e. a very small % of the premium goes towards the risk costs).
- There is no simple, intuitive way to buy good value life, disability and funeral cover online.
Developing a value proposition
Next came the Value Proposition. We believed we could use technology, digital marketing and human-centred product design to deliver simple, online life, disability and funeral insurance at a great price. We felt we could be for life insurance in South Africa what Takealot has been for retail.
We thought the world was moving far faster than incumbents realised; that millennials were ready to buy life insurance online; that we could build for the digital world and be in the right place at the right time.
And the rest flowed from there. I don’t have the time or the space to walk you through the other elements of the Canvas here, but you can probably fill in the blanks. Suffice to say, the process was invaluable and enabled us to build our business around a clearly considered business model. It’s early days, but the signs are good – we’re making a positive impact, having fun and keeping our investors happy.
Creating a Lean Canvas
So, how should you go about sketching your own Lean Canvas? The team at www.leanstack.com suggest the following approach:
- Sketch a canvas in one sitting. While a business plan can take weeks or months to write, your initial canvas should be sketched quickly.
- It’s okay to leave sections blank. Rather than trying to research or debate the “right” answers, put something down quickly or leave it blank and come back to it later.
- Think in the present. Business plans try too hard to predict the future which is impossible. Instead, write your canvas with a ‘getting things done’ attitude.
- Use a customer-centric approach. You may need to sketch one Canvas per customer segment. Start with the Customer Segment and go in sequence.
The Canvas has brought clarity and a common language to our business model design process. It’s enabled us to agree upon and communicate our business model effectively – both internally and externally. It’s also allowed us to tune and adjust our model as our story has unfolded – an inevitability for entrepreneurs. I highly recommend the Lean Canvas as a tool for designing your business model. Give it a try – I think you’ll like it.
Want To Change Your Business Model? Answer These 3 Questions
Here are a few pointers on figuring out the best way to grow your business and keep it sustainable for years to come.
To grow sustainably, is it better to take on projects that are frequent and reliable, or sparse but lucrative?
Q: I own a film and production company, and I shot 100 videos last year – 70 weddings and 30 corporate, totaling $330,000 in revenue. The corporate videos are more profitable, but weddings are always happening. I don’t want to turn off a constant source of revenue, but should I spend more time pursuing corporate events to grow my business? – Trevor R.
Welcome, Trevor, to the entrepreneur’s struggle! You build a great product or service, make good money and the next thing you know, you feel like you have to change your model. It’s the age-old question of scale: What’s the best way for your business to grow, and does that mean making less revenue now in order to have more sustainable growth for years to come?
Related: 4 Types Of Business Models
With the bulk of your time being spent on wedding videos, you probably feel stuck in the slow lane, watching better profits pass you by. But remember that scale is not just about margins.
Numbers can be deceiving, and you control what you charge for your services. While your corporate videos are more profitable right now, going all-in might not be the long-term answer.
To figure out the best route for your business, start with a clear vision of your ideal final destination. How much money – and profit – do you want to make per year? It might sound like a frivolous question (who doesn’t always want to make more?), but it will allow you to reverse-engineer your business model and help determine a practical answer.
Let’s say you want $1 million in gross revenue per year. At this time, it sounds like you charge about $5,500 per corporate video and about $2,400 per wedding video. That means you’d need to sell either 182 corporate videos or 417 wedding videos. (That’s a lot of videos!) Use those numbers to guide your vision. Next, consider scale, which depends on a number of growth factors.
First, creating value: Make sure you’re charging the appropriate amount for your services in order to reach your goals.
Second, anticipating growth: Where is the greatest opportunity, not just at the moment, but in the future?
And third, limiting expenses: How can you keep costs down so spending doesn’t outpace revenue?
Related: 3 Types Of Ecommerce Business Models
Answering honestly will help you create several business models. For you, Trevor, those models are (a) weddings and corporate, (b) weddings only or (c) corporate only. As a case study, let’s consider “weddings only.”
Last year, you worked 70 nuptials. Before you consider hitting pause on that side of your business, revisit those growth factors to figure out if you can make it more profitable.
- Should you charge more for each video?
- How many clients did you turn down last year?
- Could you have taken them on if you had extra help?
Weigh the costs, and consider adding another videographer to the staff. If that seems financially impossible, look for ways to at least maintain your current output while trimming production costs.
For a small business, profitability is a mad science of focus, projections, and getting out of your own way. What makes the most money on a per-item basis is not necessarily what will make you the most profit in the long run.
Consider Amazon: It created scale by focusing on smaller margins. It’s a helpful reminder that there are different ways to succeed.
Understand what you can charge, how you should save and who is most likely to buy from you in the future. By simplifying the complicated challenge, you can jump on the fast track to growth.
This article was originally posted here on Entrepreneur.com.
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