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How to Build and Refine 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.

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:

1. How Does The Business Generate Income?

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.

2. What Are The Major Costs Incurred in Generating Revenue?

Every business needs to incur costs to operate. Incurring costs is part of doing business but the trick is to get the maximum return on your costs. Different kinds of business will have different kinds of costs at their core. A retail business has rental and inventory at its core, for a consulting business the major cost is likely to be labour, while a courier business will incur the bulk of its costs in vehicles and technology. When projecting your costs, it is important to:

  • Identify major categories of costs affecting your business. Labour, technology, marketing, rental and capital equipment are all possible cost categories that may be at the core of your business.
  • Understand the true nature & extent of the costs you incur to reach your projected revenue & growth levels. Costs can either be fixed, variable or semi variable. Fixed costs, such as rental, imply that a fixed amount will be incurred no matter what is produced or sold. Variable costs, such as sales commission, vary depending on the amount of output that is produced and sold. Semi variable costs, such as workers’ overtime payments, increase in steps as the level of output increases.
  • Play out payment terms for major costs you incur to generate revenue. Payment will have a major impact on the cash flow of your business and it is important to know whether you will be paying for things upfront, over time or after receiving the goods or services.

How to Reduce Costs on Your Business Model

In order to think about how you can reduce costs through business model innovation consider these questions:

1. Are there clever ways of reducing costs by looking for others who can do things cheaper than you?

Example: One of the major trends in our globalised world is to find people in other countries who will do tasks at a much cheaper rate than what it would cost to get them done in your home country. Over a million US tax returns are now done in India. US accounting firms have set up processes and systems to electronically ship documents and information across to professional consultants in India, trained in US tax law, who complete the tax return at a tenth of the cost of what a consultant in the US would charge.

2. Are there ways you can change the nature of costs from fixed to variable or variable to fixed to benefit the company?

Example: African Encounters, the entrepreneurial African travel package company realised that they could reduce the cost of getting their clients to desired destinations by leasing a plane for a few days a week. This changed the flight costs from a variable to a fixed cost. Instead of paying a cost per seat on SAA or Air Tanzania, they now pay a lump sum amount to lease the whole plane. As long as they have enough people buying trips to Zanzibar, they are able to substantially reduce the cost of air travel from SA to Tanzania and some of this benefit is passed on to the customer. Smaller firms often benefit by limiting their fixed costs. It is for this reason that start-ups use freelancers and contract workers who only get paid for the work they do instead of weighing the new company down with a heavy salary bill.

3. Are there means for you to negotiate more beneficial payment terms with suppliers? Negotiating to pay suppliers for the goods or services they provide after you have used or sold those goods or services can create significant cash flow benefits and give the business a competitive advantage.

Example: Part of Dell’s business model innovation was that they negotiated to pay suppliers after they had received the cash from customers, and built and shipped the computer. Pick n Pay negotiates similar arrangements with its suppliers: It gets the goods on its shelves, sells them two to five days later, collects the cash and pays suppliers 90 days later. As a result, Pick n Pay has access to large amounts of interest generating cash that can be used to finance growth.

3. What Investments Are Required to Build and Sustain The Business?

Once you understand the cash flow implications of costs and revenue, it is important to use this information to calculate what size investment will be required to sustain the business through its initial negative cash flow. Almost all new projects, initiatives or ventures go through a period during the early growth phase when they use more money than they make. Depending on the nature of the business, the amount of time and level of investment required to sustain the business through this time will vary. Entrepreneurs and business managers must calculate accurately the size of the investment required for any new project, initiative or venture in order to ensure that they have enough money to build a sustainable business.

Fine Tune Business Model Innovation on The Investment Element

Innovating on the investment dimension of a business model is less common. There are, however, a number of things that you can do to enable innovation.

  • Provide sufficient investment to give a new business model time to work. Customers and suppliers don’t buy into new ways of doing things immediately and it often takes time for a new business model to take hold. If you don’t have enough investment to see you through the period when the new business model is gaining traction, then the model is likely to fail.
  • Provide sufficient investment to allow for some experimentation. The perfect business recipe is very seldom the first recipe you try out. You will need to experiment a little and experimenting takes money. Most new business models go through three to six iterations before the manager discovers a model that works well.

4. What are the critical success factors for the business?

Critical success factors are the actions and outcomes that will have a significant influence on a project or venture. The entrepreneur or business manager must rely on research, intuition and brainstorming to identify such critical issues. It is important to be precise and explicit in identifying such issues that could include sourcing the right location, fostering an important partnership, securing a big contract, creating a powerful brand or scaling up to a certain size.

Fine Tune Business Model On The Critical Success Factors

In order to ensure that you are being innovative in deciding on your critical success factors it is worth having two groups of critical success factors. Group one are the critical success factors that allow you entry in the game – the things that you must do just to compete with the businesses that are currently operating in your industry. This may include things such as high foot traffic location, a quick and functional website or nationwide distribution. Group two are the critical success factors that will differentiate you from the competition – the things that will cause your business to stand out from the crowd. These may include things such as widest selection of designs, unique and innovative website feature or same day delivery (when no one else is able to do it).

Both groups of critical success factors are important; the first group provides access and the second enables success. The four concepts of revenue, costs, investment and critical success factors pulled together into a single story, spreadsheet or diagram clarifies the business model for a venture or project. A business model is an interdependent system in which all the components interrelate with one another. To ensure that it is workable and flexible, you should make every effort to understand how the components interrelate and what the impact of a change in one component of the model will mean for the other components. Don’t be afraid to experiment a little with your business model, test different ideas, get feedback from customers and work with employees to ensure you are creating a system that maximises your business success.

Greg Fisher, PhD, is an Assistant Professor in the Management & Entrepreneurship Department at the Kelley School of Business, Indiana University. He teaches courses on Strategy, Entrepreneurship, and Turnaround Management. He has a PhD in Strategy and Entrepreneurship from the Foster School of Business at the University of Washington in Seattle and an MBA from the Gordon Institute of Business Science (GIBS). He is also a visiting lecturer at GIBS.

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How to Guides

The 10 Commandments of Social Entrepreneurship

How does a business, with a definitive social drive, practically draw the tricky equilibrium and make a difference without sacrificing the bottom line? by Lisa Illingworth, CEO and co-founder of educational start-up Futureproof and Development Sector Consultant for Evolve, Silvia De Jager.

Silvia De Jager

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The emergence of social enterprises on to the business landscape of the South African economy is often a point of contention due to the seemingly conflicting driving factors of philanthropy versus profit. However, there are many businesses that are underpinned by solving problems for the benefit of society at large and out of this has arisen this area of entrepreneurship.

The Gibbs Social Enterprises in South Africa Report released in 2018, give interesting insight into the growing application of this business model in the South African context but they note, as most social entrepreneurs will have first hand experience of, there is a subtle but very real balance to be struck between purpose and profit. How does a business, with a definitive social drive, practically draw the tricky equilibrium and make a difference without sacrificing the bottom line?

1. Do your research

Ensure you know your market, understand their needs and don’t make assumptions. Social enterprises are much more complex than your regular business and require a lot more research. They have various customer sets, that are either direct or indirect and blending those in operations that meet those expectations is a delicate dance.

“In FutureProof,” comments Lisa Illingworth, CEO and co-founder of FutureProofSA. “We don’t define our customer sets based on what they are prepared to pay for, but rather on what problem we are solving and for whom. This means that the children, their parents, the schools and the management, our coaches as well as those in the corporate space all have various needs and expectations of how those are met. Thus, we have 5 different types of customers and we sell a variety of solutions to each of these, even though some are paying directly for our services.”

2. Remember it’s a business

You want to achieve social impact, but your priority is to ensure you make enough revenue to not only sustain the social enterprise, but to also allow for growth. As a business, you should instil good business practices such as processes, financial planning, legal structures and governance.

A social enterprise is a lot like the human body, if you feed it only enough to survive, growth will be stinted. Give the body more than what it needs to function for the day and growth will be proportional. Don’t sacrifice your profit at the altar of purpose.

3. Allow for flexibility

Have a flexible mindset. When the market is changing, you won’t survive staying the same. If your solution is no longer addressing the problem you are trying to solve, it’s time to go back to the drawing board. How you adapt is important and getting regular feedback from those you are serving as well as those who are paying- whether they are one in the same person or not.

Just because you are doing good work in your own mind, creating a transparent feedback loop, will prevent your business from being infatuated with the vision despite the market losing interest in your solution.

4. Take calculated risks

Be prepared to take risks but do your homework first. This is how you learn and grow both as a business and as an individual. Which means having the mechanisms and people in place to collect the data necessary to take informed steps towards opportunities aligned with the purpose of the business but not at the expense of still turning a profit.

You will never know every risk and it’s potential upsides or downsides, but having enough information that is unbiased can help make better business decisions and maintain both impact and shareholder value.

5. Focus on sustainability

sustainability

Keep your eye on remaining sustainable at all times. Keep in mind that sustainability is not only financial, it includes your operations and programmes. Socially minded entrepreneurs often make head decisions with their hearts and end up with an operationally capital-heavy structure. Hiring people based on contract positions and keeping overheads flexible will ensure that as your opportunities fluctuate, so the business can adapt accordingly and weather the famine times but grow in the seasons of abundance.

6. Have a clear mission

Have clarity on your purpose and how your business will achieve it. Ensure you have a strong Theory of Change for how you will create and deliver your social impact and develop an ability to clearly communicate it to everyone, both inside and outside of your business. This will also keep you, your team and your business from getting sucked into solving all the social sicknesses that exist in the area that you practice.

7. Network

Widen your circle. Support can include conferences, business networks, fellowships, mentorships, workshops, training, incubation and shared workspaces. Don’t focus on simply expanding your social circle into those in similar fields but look outside to those with varying perspectives, yet aligned in values and culture with your organisation.

8. Build a strong team

There’s an old African proverb that says “If you want to go quickly, go alone. If you want to go far, go together.” Don’t ever assume you can do it alone. Invest in a team that can support you, both on a personal and professional level and ensure that they are not only focused on the purpose of the business, but the way in which the purpose is achieved.

Ensure you are being coached in both a personal and professional capacity so as to maintain the momentum for yourself and your team.

9. No Grit – No Pearl

pearl

You have to possess grit — perseverance and passion is essential and will get you a very long way. The refining of this business model is more complicated as the numbers may not be the only measure of success. Know what good looks like for your business and be prepared to have the hard conversations to refine your offering to meet both an impact measure as well as a profit measure.

10. Enjoy the journey

You chose this journey because you wanted to make a positive difference in the world. It’s not going to be plain sailing, but that doesn’t mean it shouldn’t be fun. Learn to enjoy the process and glean as many lessons as you can, from all sources, in the shortest time frame possible. Entrepreneurship is too hard, not to learn from the mistakes of others.

Finding that healthy tension between serving a purpose and making a profit is complicated and yet possible. One of the major benefits of running a social enterprise is that people are drawn to working in these types of businesses over those strictly increasing shareholder value. Employees feel as though they are serving something more than just making themselves and others rich, as long as the balance can be maintained with a constant activity of business introspection.

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How to Guides

How To Start A Car Dealership

Below are some tips on how to start.

Amy Galbraith

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car-dealership

If you are passionate about cars, then starting a car dealership might sound like the perfect business opportunity for you. You will be able to be your own boss and you can spend time around products that excite you, such as Nissan Qashai used cars, or luxury pre-owned cars, and used cars for business owners. But, you might not know where to start when planning your car dealership business.

If you want to open a franchise there are steps to follow. All car dealers need to have the correct documents in order when applying for buying and selling rights of cars, and you need to have the service history of all cars for sale on your lot. Interested in opening your own dealership or becoming part of a franchise?

Do your research

Before you jump right in to finding the perfect location for your car franchise or business, it is important to perform some market research into the industry. The first step is determining the demand for your particular service, which is providing used or second-hand cars for sale to the public.

Look at how many cars have been sold in your town recently, assuming that most people are willing to travel up to 16km to find a car. This might show you that in your area, up to 100 000 cars have been sold in a year. This is a significant demand, which will mean that your business model is a viable choice. Find out which people prefer used cars over the pre-owned vehicle options to further help your decisions.

Create a business plan

Once you have performed your research, it is time to create a business plan. You need a business plan to show any prospective franchisees and franchisors or for explaining to your lender exactly what you want to do with your car dealership business. It should include your initial and ongoing costs as well as what your working capital is.

The most important part of your business plan will be the cars themselves. For example, will you be selling new, used, or pre-owned vehicles? Will you be focusing on one brand or offering multiple brands? Answer these questions first and remember to include costing for salaries, lease agreements, and other business costs. Another important part of your business plan include how you will raise money to repay any loans or finance agreements you might have.

Have the right documents

After finalising your business plan, you should do some research into what documents you need to continue. In South Africa, this includes a dealer’s license which allows you to legally buy and sell cars to the public. It ensures that all of your business activities fall under the consumer rights and protection act.

You will also need to have documentation showing that you are leasing or own the property you will be operating from. You should look into a surety bond, which will protect you from any damages to the property. Speak to your lender about the other documents that you need for a franchise agreement, as these might be slightly different from what is required for a normal dealership. Also be sure to provide the correct documents to those you are purchasing used cars from.

Investigate inventory opportunities

The most important aspect of owning a car dealership is, of course, having cars to sell. This means that you will need investigate inventory opportunities, such as going to bank auctions to find cars that you can bid on and then resell at a fair price, or you could offer to purchase used cars from people who need to sell them and then resell these after much needed repairs and sprucing up.

You should always keep your budget in mind when purchasing inventory, as it can become costly if you are continuously running over-budget on purchases. This is when it is important to keep your business plan in mind as it will show you exactly how much you have to spend on inventory so that you can stick to this budget. If you would like to appeal to those who have discerning taste, you should remember that luxury vehicles might cost more than others.

Don’t forget about marketing

Once you have done your research, drawn up a business plan, and found all of your inventory, start working on marketing your business. Invest your money in a company that can help you to reach your audience by using modern digital tactics as well as traditional techniques of marketing. Remember to have the right documents together so that everything is legal and above board before you open your doors. Soon your car dealership will be booming and you will be helping people to find the cars of their dreams.

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Got An Awesome New Business Idea? Here’s What To Do Next

If you’re stuck in the brainstorming stage, the first step is to focus on two questions: ‘Why?’ and ‘Who?’

Syed Balkhi

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Do you constantly have great business ideas which fall to the wayside because you just don’t know how to turn those daydreams into reality? If you’re stuck in the brainstorming stage, that’s probably because you don’t know what to do next.

Around 550 000 people, according to the Kauffman start-up index, become entrepreneurs each month and you could be one of them. While there’s no guaranteed formula to starting a successful business, there are steps to take in the planning phase that will not only help you determine if your business idea has what it takes but help you get the ball rolling, too.

Sound like you? Here’s what to do next.

Determine the “why” and the “who”

The first step to take after you’ve come up with a new business idea is to concentrate on the “why” and “who” of it. You may think you’ve thought up an awesome idea, but your business won’t be successful if you don’t know the real reasons behind why it’s a good solution, and whom it would be a good solution for.

Start to really think about what problem your business idea solves. Your business may solve a problem for you, but does it solve a problem for others? If nobody else has the problem that your business proposes a solution for, then who will buy that solution?

After you’ve taken a deep dive into why your business is needed in the first place, determine who will be the target audience of your business. Think about the demographics of your target audience, what’s important to these people and how you will reach them. You can use a free tool like Hubspot’s Make My Persona to get detailed about who your ideal customers are. A business isn’t a business without customers, after all.

Related: 10 Business Ideas Ready To Launch!

Search for similar solutions

No business idea is 100 percent unique; there will always be businesses out in the world that are similar to yours. So, don’t sweat it if there are companies doing what you do; in fact, that proves there’s a market for what you do. What you do have to think about is who your competition will be, what exactly they are providing and what you will do differently or better than they do.

To stand out from the competition, you will need to know what sets you apart. Start doing research on the companies that could become your competition. Look at how much they charge, who their target audience is and how they market to them, to name just a few research points. There’s no need to reinvent the wheel, but do look at what these companies are lacking in and how you can improve upon those areas in your business, so that you capture their customers.

Talk to your potential customers

Similar to your efforts to study your potential competition should be your effort to study potential customers. Get out there and start talking with your target audience. See if your product or service is something they would use, find out how much they would pay for it and ask what comparable product or business they’re using now to solve the problem.

You could even get super in-depth and ask people to fill out a survey providing answers that will help you get to know your audience even better. Even negative feedback about your business idea can help you refine your idea.

Lock down the details of your business

Coming up with a new business idea is exciting; your mind is probably buzzing with lots of plans and designs – maybe too many. So, sit back and lock down the finer details of your business. Will you be offering a product or a service? How much will it cost? How will you be marketing your business? You need to know your new business concept inside and out before you launch. A great and easy way to organise your thoughts is to use a business plan software like LivePlan.

Also, if you haven’t named your business yet, now’s the time to do it. Do some brainstorming and come up with a name that no one else has already taken.

Related: 20 Quick Money-Making Business Ideas

Determine the “how”

After you’ve worked out all the details of your future business, the next step is to figure out how to turn your dream into a reality. Obviously starting a business costs quite a bit of money, so that’s one of the major “how” factors you need to consider. Decide if you’ll talk to investors, take out a loan, or maybe even start a Kickstarter campaign.

Determine everything you’ll need to get your business up and running. For instance, if you’re offering a product, how will you build it and how much money will it cost? This last step is one of the most important in order to take your business from out of your head and into the real world.

Over to you

What are you waiting for? By following these tips, you’ll be well on your way to starting your very own company. If you take the time to plan out your new business idea, you won’t just build a business, you’ll build a successful one.

This article was originally posted here on Entrepreneur.com.

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