Categories
Business models

What is a business model?

Business model has become a huge buzzword. If you google it, you will find a substantially larger number of results than for almost any other business-related concept (let me know if you find any). In fact, the number of results is considerably higher even when compared to the results of searches such as Brexit”, “Donald Trump”, or “climate change. In my experience though, many people have started to use this word without really knowing what it means. It is often used loosely or confused with other concepts. So what is business model, really?

The bad news is that dozens, or even hundreds of definitions exist. The good news is that there is a consensus on the fundamental meaning of the business model concept. According to this consensus,

the business model is a company’s enactment of its strategy to create value for its customers and to capture some of that value for itself.

In essence, the business model is what the company does to make money. Value creation refers to the offering, while value capture relates to earning money. For example, Uber creates value by offering a platform that connects passengers who want to get from A to B, with drivers who are willing to take them there for a 75% share of the total fare that is determined by Uber’s algorithm. Uber makes money by capturing 25% of the total fare for itself.

It is important to distinguish business model from strategy. If business model is what the company actually does, strategy is the (long-term) plan for how to achieve its goal(s). Hence, business model is the enactment of the company’s strategy, that is, what the company actually does to realize its strategy.

Business models can be visualized in many ways to illustrate how a company works or what it does. I write more about this in a separate post (coming soon). Here, I use one that I developed myself.

Problem

The company realizes that a problem (customer need) exists, and that no company is offering a solution or that it has a better solution to the problem than any of the existing ones. A problem can be either discovered through market research or created. A problem creation is a typical visionary process, in which the company’s potential customers did not even know they had that problem. Steve Jobs once said “It is not the customer’s job to know what they want.”

Input and Solution

Knowing there is a customer need, the company uses its input (resources and activities) to create a solution (output). This process is what we mean by value creation. The solution contains two types of value: use value and exchange value. Customers gain basic value by using the product/service for the basic need (for example a chair allows for sitting), and they may gain extra value if the product/service meets their specific needs, for example design wise (a luxurious chair at a five-star hotel lobby). Exchange value refers to the price, which typically consists of cost of production and margin.

Monetization

The company monetizes its solution by selling either the ownership of or access to the offering. Products are typically purchased for ownership while services are for rather access. Many solutions can be monetized through both ownership sales and access sales. For example, a bus company would typically acquire several buses from the manufacturer (ownership) and then offer its customers bus rides from A to B. But, for example Flixbus, a German intercity bus service, does not own a single bus but it leases them from the manufacturer (access). Thus the bus manufacturer sells both ownership and access.

Conclusion

In sum, a company’s business model is what it does to make money.

This includes several interconnected elements that need to be aligned such that the overall business works smoothly. The solution’s exchange value (price) needs to be aligned with the customer need and input cost. The monetization type has to be aligned with the customer need and the input, since selling ownership and access require different kinds of resources and activities. The solution’s use value in turn must fit the customer need exactly but of course also the input available and the type of monetization intended. Hence, overall the business model can be seen as a configuration of several elements, and as an architectural design of the whole company. Read more here about how to best explain others what your business model is like.

Leave a comment