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What is a business model?

4 May, 2016 - 10:39

Business models can be approached from two perspectives. A general perspective defines a business model as any type of conceptual framework explaining how to organize and evolve a business venture. On the other hand, specific circumstances guide business modeling. For instance, industries such as tourism, banking in the services sector, or automobile or shoe manufacturing demand specific models that take into account critical variables found within the industry’s specific environment.

One definition from the general perspective is provide by Alex Osterwalder:

“A business model is a conceptual tool that contains a set of elements and their relationships and allows expressing the business logic of a specific firm. It is a description of the value a company offers to one or several segments of customers and of the architecture of the firm and its network of partners for creating, marketing, and delivering this value and relationship capital, to generate profitable and sustainable revenue streams.” (Osterwalder 2005, Accessed November 25, 2007).

Models are simplified representations of things in the real world. You are already familiar with many kinds of models. You have played with a model air plane or boat when you were a child. You may have seen models of buildings, dams, or other construction projects built by architects to show the sponsors of a project how a completed building will look after it is built. In the same way, a business model lets an entrepreneur try out different ways to put together the components of his or her business and evaluate various options before implementing the one that looks the best. This technique is especially important in today’s business environment, where technology gives business people so many more options than ever before.

Osterwalder goes on to say:

For managers and executives this means that they have a whole new range of ways to design their businesses, which results in innovative and competing business models in the same industries. Before it used to be sufficient to say in what industry you were for somebody to understand what your company was doing because all players had the same business model. Today it is not sufficient to choose a lucrative industry, but you must design a competitive business model. In addition increased competition and rapid copying of successful business models forces all the players to continuously innovate their business model to gain and sustain a competitive edge.

Based on his search of the literature, Osterwalder lists nine building blocks for managers to use in developing an innovative and effective business model. We list them, along with some comments of our own:

  • “The value proposition of what is offered to the market”; We have covered this issue earlier in the chapter in general, and with specific reference to how Porter’s analytical tools can assist managers in generating a viable value proposition that consumers perceive as one that is superior to what is offered by the competition.
  • “The target customer segments addressed by the value proposition”; Managers soon learn that they cannot be all things to all people, that what appeals to one segment of the market will not appeal to another. We will discuss this in more detail later in this chapter.
  • “The communication and distribution channels to reach customers and offer the value proposition”; This issue relates to two of the “four P’s” (promotion and place) we discussed briefly when we discussed the marketing mix. For example, do we promote the business by word of mouth, signs on a storefront, ads in a newspaper, ads on TV, ads on the Internet, or some combination of all of these? Place refers to where the product or service is made available to the customer. The three usual choices are in a store, through a mail-order catalog, or from an Internet website.
  • “The relationships established with customers”; In general, however, the important point is not just to acquire customers, but to serve them in a way that your business retains them as customers. For example, it is usually much more expensive to attract a new customer to your business than it is for you to encourage a previous customer to return.
  • “The core capacities needed to make the business model possible”; This point refers to the necessity to define the basic capabilities your business must have. For example, if you are opening an art gallery to sell your own work, you had better have some talent as an artist!
  • “The configuration of activities to implement the business model”; Another way of stating this is to define the business processes that your business must have in order to function properly.
  • “The partners and their motivations of coming together to make a business model happen”; Partnerships and alliances are increasingly important in today’s world.
  • “The revenue streams generated by the business model constituting the revenue model”; In essence, this is the Price component of the “Four P’s”. Where does your revenue come from, what are the projections for the future, and what are the plans to sustain the necessary revenue stream as business conditions change?
  • “The cost structure resulting of the business model”. The difference between revenues and costs, of course, is your profit. Without a profit, it will not be possible for you to stay in business very long.