Businesses make money in different ways. For example, a manufacturing business buys raw materials or components and transforms them into a product that delivers a unique value. A wholesaler, on the other hand, does not make anything but delivers value by providing distribution services to the manufacturer and a varied mix of merchandise to the retailer. Business models show how businesses create value for customers and generate revenue for themselves.
What is a Business Model?
A business model is a description that communicates the essence of:
- What a business does and
- How it makes money doing those things (Do Some Business Models Perform Better than Others?)
The model explains the design underlying the business' operations, and is often communicated in a graphic format such as a Business Model Canvas.
The MIT publication cited above recognizes four basic types of models with four sub-categories under each. Of the sixteen categories thus identified, seven were found to be most common and accounted for nearly 100% of businesses in the US.
The four basic types are:
- Creator: Creators design (and often make) the products that they sell to customers, who acquire full ownership rights to these products (to use, sell, dispose off or destroy). A manufacturer is an example.
- Distributor: Distributors also sell full ownership rights to their customers but do not design or make the product, though they might add some value such as buying convenience and customer service. Wholesalers and retailers are examples of distributors.
- Landlord: The term landlord has a much wider meaning in business model context compared to its conventional meaning. In the present context, a "landlord" is any seller who sells only a right to use the product (under specific conditions or for a limited period) to the customer. Airlines that sell passenger seats and banks that lend money to be returned after a certain period are examples of landlord business models. Even service providers who sell temporary use of their services to customers come under this category, as do Microsoft that sells a "license" to use its software.
- Brokers: Brokers provide a matchmaking service to bring together buyers and sellers in return for a commission. Examples include real estate brokers, stock brokers and employment agencies.
Each of the above models might involve dealing with:
- Physical Assets: Creators and distributors might sell durable assets like houses and computers, or perishable stuff like food. Landlords might rent out a house, car or other products. Brokers might bring together a buyer and seller for a physical asset.
- Financial Assets: Creators might create innovative financial products (that can even lead to a financial crisis), which might be distributed by a financial trader. More commonly, however, financial "landlords" like banks and insurance companies make money available to their customers for temporary use or on the happening of certain events, while financial brokers help you trade in stocks and bonds by putting you in touch with sellers.
- Intangible Assets: Inventors are creators of Intellectual Property (IP) and there are IP traders who distribute them and IP brokers who bring buyers and sellers together. More numerous are IP landlords like Microsoft, Publishers and Franchisors who license their offers to customers.
- Human Assets: While you cannot sell as a creator or distributor "human assets" on full ownership basis to customers (because it is illegal), you can temporarily make available the services of your human resources as a contractor or broker (HR agency).
Business Models Help Make a Good Business Plan
An intensive review of your business model will focus your attention on key business result areas such as:
- The customers you want to reach and how they are typically reached
- The package of customer benefits needed to attract your prospective customers
- The kinds of resources - physical, financial, human and intellectual - that you will need to market and deliver your value proposition
- The process/information/work flows involved in carrying on your business operations
- The costs of setting up and running the business
- The revenues you can generate with the kind of setup you have created
By developing appropriate solutions for all the problems highlighted during the review, you have the opportunity to create an excellent business plan. Such complete business plans will find much greater acceptance among investors and lenders.
In this article we focused on what is meant by a business model and also looked at how it helps business plan development. In a separate article, we will look at how business models help strategy formulation.
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