Few things are as important to a company as its business model. Your business model serves as a template and guide for just about every part of your business. It's essential to not only create a business model that reflects how you will make money, but also adapt it over time as the needs of your market change.
How does a business model work? What are some common types of business models? This guide will introduce you to business models and provide a helpful guide so you can create your own.
Business model definition
A business model explains an organization's core strategy for running a profitable operation. It describes what will be sold, how revenue will be generated and how the customers will pay.
Business models capture the rationale and the plan for creating and delivering value. Business models also reflect the company's unique value proposition, which is the essential way in which the company meets the market’s needs.
Key components of a business model
While every company's business model will look different, a successful business model will contain the following key components:
- A description of the products or services (including the cost of manufacturing)
- A strategy for distributing that product (marketing, delivery, merchandising)
- How the customer pays (pricing structure, payment methods)
Your business model integrates all of the components of your business and organizes them into a cohesive structure.
Business model vs. business plan
The term "business model" is sometimes used synonymously with "business plan." However, the two documents serve slightly different purposes.
A business model is a holistic portrait of how the company operates. Think of a business model as an aerial photograph of your organization, giving you a comprehensive view of your current and future operations.
A business plan refers to the specific strategy for accomplishing a particular goal. A business plan is more like the turn-by-turn directions you receive on your GPS device.
The business model and business plan must be in alignment, but the business model explains how you will succeed while the business plan shows how you’ll get there.
Why choosing the right business model is important
Writing for the Harvard Business Review, Joan Magretta explains that business models matter because they tell a specific story about your company. Your company's "story" explains how all the pieces come together and connects this narrative to your raw financial numbers.
Business modeling is, therefore, important for at least three groups of people:
1. Your company's employees
Your business model determines the scope and strategy of your business processes. It's important for you and your employees to understand your existing business model, as well as how it translates into your day-to-day activities.
But more than that, a successful business model will also provide a vision for the future, which empowers established businesses to improve their cash flow and make expansion plans.
2. Your target customer groups
Successful business models also create value for your business and help you communicate this value to your target customer segments. While your key customers will likely never read your business model, it should help you strategize ways to communicate your unique value proposition to your customers.
Investors will also need to understand your business model. Ideally, your business model describes a clear strategy for meeting a market need, establishing your goals, and setting a long-term vision. A clear business model will help you gain the confidence of investors and secure funding.
What are common types of business models?
There are many different types of business models, with new models emerging as entire industries adapt and grow. The following list is not exhaustive but represents some of the more common business models in use today, along with some business model examples to illustrate how they work in the real world:
Manufacturing business model
A manufacturing business model focuses on the production of goods by sourcing raw materials and using a standardized production process. Manufacturers typically sell their finished products to retailers and other distributors, though some manufacturers also sell directly to consumers.
Examples include Ford Motor Company, Frito-Lay, and Whirlpool.
Retail business model
Retail is likely the most familiar business model for most American consumers. A retailer purchases finished goods from a manufacturer or distributor, then sells these products directly to customers.
This setup usually takes place inside brick-and-mortar stores, though many companies are adapting their business framework to offer online options.
Some of the most common retail business model examples include stores such as Target or Wal-Mart.
Franchise business model
A franchise business model might overlap with other business models, though the key difference is how the business is structured. In the franchise business model, a franchisee purchases the rights to a business from the franchisor or parent company.
The franchisee then operates under the established brand, which gives them more stability than if they'd launched their own business from scratch.
Common franchise business model examples include McDonald's, Ace Hardware, and Planet Fitness.
eCommerce business model
An eCommerce business model functions similarly to a retailer, though it relies on online platforms to advertise products and conduct transactions. eCommerce companies also utilize delivery companies to transport products to their customers.
The most common eCommerce business model example is Amazon.com, though retailers like Target and Wal-Mart have also launched eCommerce segments.
Freemium business model
The freemium business model is popular among technology companies. Freemium business models blend free and paid features on the same platform. The idea is simple: customers who enjoy the free service can be encouraged to sign up and pay for access to premium features.
Flickr, the online photo app, is a good example freemium business model, though many companies offer introductory services before promoting their premium features.
Advertising business model
Advertising companies are third-party organizations that help connect other businesses to their core customer segments. Essentially, the business’s users and customers are two different groups. Strategies can vary widely, especially when digital companies offer print ads, internet marketing, and content for social media platforms to help their clients expand their advertising reach.
Facebook, Instagram, and TikTok all fit into this business model.
Affiliate business model
An affiliate business model is similar to an advertising model, though an affiliate business strategy is more subtle. Instead of clear, overt advertisements, an affiliate business will embed links into other content to drive sales.
For instance, an affiliate business might link to Hulu when writing a review of popular streaming platforms.
How to create a new business model
Creating a new business model is important when launching a startup, but many companies create entirely new business models to adapt as they grow. Here's how to create a new business model that works for your unique industry:
1. Define the problem
First, determine the problem or need that your company can uniquely address. Identifying the problem can ensure that there is a demand out there for your products or services.
Every business idea should start with the question, "Why?" Why does your business exist? What need does it fill? Why will customers want to purchase your product? Keeping this understanding center of mind will help you stay focused throughout the process.
2. Identify your target market
A good business model will focus on specific customer segments. Who are you trying to reach? This insight will help you refine your marketing efforts and product features based on the demographic groups you seek to build relationships with.
3. List your products or services
The next step is crucial. You want to list and describe your products and services and explain clearly how these satisfy the need you defined in step 1. It's important to ensure that your team’s expertise matches the products and services that solve these needs.
For example, if you have a background in personal finance, you might consider how a new accounting software system might assist certain types of established businesses. This stage tends to be iterative, meaning you'll come back and redefine your product offerings based on feedback and adapt them to new market needs.
4. Determine your business needs
Once you zero in on your products, you'll want to determine what you'll need to connect them to your customer base. This calculation can include costs incurred from
manufacturing/product development, as well as the need for personnel, marketing, and other expenses.
5. Build a network of key partners
Depending on the nature of your business, you may want to network with other professionals. For example, if you're relying on a retail business model, you may want to start networking with distributors, manufacturers, and other industry players.
You may want to consider if there's an eCommerce platform you'd like to use in conjunction with retail sales or if there are business tools that can help you run your business more efficiently.
6. Create a financial strategy
Successful businesses use their business model as a financial model to calculate their overall profitability. You'll need to determine how you intend to make money, including things like cost structure, profit formula, pricing, and other core considerations.
A successful business model will ensure that you satisfy the need you identified in step 1 while generating profits that help maintain and grow your operations.
7. Test and refine your model
The most successful companies will test their existing business models to determine how well they're performing. This work might reflect things like customer feedback, financial performance, or the need to adapt to new market conditions.
Here's a tip: conduct a "soft launch" of your business for a select group of customers. Offer discounts in exchange for honest feedback. Incorporate their feedback into your business model design, then proceed to a full-scale launch once you've refined your model.
How to improve your business model
If you've had the same business model for years, it may be time for a review. Improving your current business model can help you adapt to new technology, changing costs, and new customer demands. For example, if an advertising firm's business model doesn't take into account new social media platforms, the company may miss out on opportunities to connect with its audience.
Here are some strategies for business model innovation and improvement:
Listen to customer feedback
Turn your existing customers into coaches. Product and company reviews can be a gold mine for information about current client needs and how well your company meets those needs. You may discover new ways to innovate and adapt.
Lower your overhead
If your company struggles to make a profit, you may want to rethink some of your overhead costs. For example, automating some of your core business processes through technology can help your employees work more efficiently, reducing the number of hours you spend on back-office tasks.
Introduce a new product or service
When your company has been offering the same products and services for years, it might be time to shake things up. Introduce a new product or service to demonstrate your value to your customers, or use this as an opportunity to gain a whole new set of customers.
Reconsider your revenue model
Your current revenue model may be based on an outdated price structure. It may be that the cost of manufacturing or rising inflation warrants an increase in the price of your core products and services.
If you operate a subscription-based service (or a freemium model), you may offer discounts to existing customers while raising the price of a product or service for new customers.
Change your marketing message
Your marketing campaign is how you tell your story. If your story changes, so should your marketing message. Refine your marketing strategy by adapting to new digital channels, or consider developing content that directly impacts your target audience.
How BILL can help improve your business model
Creating and refining your business model is just one way to run a successful business. BILL can help small and mid-size businesses save 50% of the time they spend on accounts payable. Learn more about how to pay smarter.