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Saturday, November 05, 2005

 

What is a business model?

Update: In addition to this post check out the business model design template

The topic of business models has become important in today’s competitive landscape. The capacity to manage continuous change and constantly adapt to rapidly changing business environments by introducing new business ideas and concepts is nowadays indispensable for companies to thrive and survive. The business model concept is a particularly helpful unit of strategic analysis tailored to today's business environment.

But what actually is a business model?

Let us take a step back and really ask ourselves what we mean when we talk about business models. How do we define what a business model actually is and how could we describe the business model of our own company?

Under a model I understand a simplified description and representation of a complex real world object. A model describes the original in a way that we understand its essence without having to deal with all its characteristics and complexities. In the same line of thought we could define a business model as a simplified description of how a company does business without having to go into the complex details of all its strategy, processes, units, rules, hierarchies, workflows, and systems. However, now that we know that the business model is a simplified representation of how we do business, we still have to decide which elements to describe. A synthesis of literature shows that there are mainly 9 building blocks to help us describe a business model:

  1. The value proposition of what is offered to the market;
  2. The target customer segments addressed by the value proposition;
  3. The communication and distribution channels to reach customers and offer the value proposition;
  4. The relationships established with customers;
  5. The core capacities needed to make the business model possible;
  6. The configuration of activities to implement the business model;
  7. The partners and their motivations of coming together to make a business model happen;
  8. The revenue streams generated by the business model constituting the revenue model;
  9. The cost structure resulting of the business model.

Definition:

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.

Origins of the term business model

The term business model became popular only in the late 90s, which, personally I thnk is related to the rapid erosion of prices in the IT and telecom industry. The roots of my assumption lie in Transaction Cost Economics (TCE). Because it became so cheap to process, store and share information across business units, companies and all the way to the customer many new ways of doing business became possible: Value chains were broken up and reconfigured; Innovative information-rich or -enriched products and services appeared; New distribution channels emerged; More customers were reached. Ultimately this lead to globalization, increased competition , but as described above it also led to more ways of doing business. In other words today there is a larger variety of what companies do, how they do it and for whom they do it...

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 where 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.

Companies that thoroughly understand their business model and know how the building blocks relate to each other will be able to constantly rethink and redesign these blocks and their relationship to innovate before their business model is copied.

Business Models & Innovation

The term business model is also closely related to innovation. As I mentioned the business model concept is related to a whole new range of business design opportunities. There are examples of business model innovations in each of the 9 building blocks described. The most obvious is innovating in the value proposition. When mobile phones appeared in the market they offered a different value proposition than fixed line phones. In the early days of the Internet popular indexes like Yahoo! helped people find information on the Web. Regarding target customer segments, low-cost airlines like EasyJet have brought flying to the masses. Dell became really successful by exploring the web as a distribution channel. Gillette has made a fortune by establishing a continuous relationship with customers based on its disposable razors. Apple resurged based on its core capacity of bringing design to computers and electronic gadgets. Cisco became famous for its capacity of configuring activities in new and innovative supply chains. Intel thrived for its capacity to get partners to build on its processing platform. Google tapped in an innovative revenue streams by linking highly specific search results and content with text ads. Wal-Mart became dominant by its ability to slash cost throughout its business model.


Comments:
This is a great synthesis of research on business models. There is a group here at Wharton (University of Pennsylvania) focused on business model wars which addresses how the various elements of your 9-component model correlates with business success.
Having worked with many turnaround situations I have to admit that this is a little understood concept for most CEOs.
 
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