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Business Models

A business model describes the rationale of how an organization creates, delivers, and captures value. It can be an essential differentiator, particularly in very competitive industries. Many of the most successful startups innovate primarily in terms of their business model, rather than for instance the underlying technology.

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Defining and reviewing the business model is a key element of the overall strategy process.

Business models are not simply answering the question "How are we going to make money" — that's an essential, but by no means the most important part. At the heart of every business model is the value proposition — the value the company promises to deliver to its customers. Defining the value proposition in a tangible and precise way is the precondition for the business model development process.

A business model has to answer the following key questions:

  1. Value proposition: What value are we going to provide to our customers?
  2. Input factors: What resources do we need to provide this value?
  3. Sales channels: How is the product or service going to be delivered to customers?
  4. Cost base: What will the cost be to provide the product or service?
  5. Revenue model: How are we going to generate revenue from providing the product or service?
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Business model innovation is possible in any of these dimensions. Often it is most effective if multiple aspects are changed at the same time compared to the competition.

Consider the case of Amazon's early business, which focused on books. It changed the value proposition (largest selection of titles), the sales channels (online ordering, mail delivery), and revenue model (best prices you can find) at the same time.

Patterns

While every company's business model is different, there are some standard categories of successful business models that can often be found in the startup world. It's often a good idea to understand these successful patterns and decide if and how they might be applicable to your own startup.

Typical patterns (based on Hoffmann and Yeh's book "Blitzscaling") include:

  1. Digitization: Providing value in the form of bits instead of atoms. Digital music streaming (which almost entirely replaced physical music distribution) is a typical example.
  2. Platforms: Many of the most successful tech businesses are platforms. Platforms provide an infrastructure for 3rd parties to provide value to customers, and they typically generate strong network effects in the process.
  3. Free and Freemium: The economics of digital products enable companies to provide substantial services for free due to near zero marginal costs. This enables viral growth and creative monetization strategies.
  4. Marketplaces: As a special form of platforms, marketplaces consolidate supply and demand in a particular market, often connecting buyers and sellers that otherwise would never have found each other.
  5. Subscriptions and recurring revenue: This form of monetization is highly attractive because it provides stickiness, predictability and robustness. For example, the software industry has almost completely moved to subscription-based models from its original approach of charging a large price for a piece of software upfront.

Tools

The business model canvas by Alexander Osterwalder is a great starting point for the definition and periodic review of business models. It covers all necessary ingredients on a fairly high level of abstraction, which sets a good foundation for the further detailing of the relevant elements.

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The template can be downloaded on Strategyzer's website.

Useful Resources

Osterwalder: Business Model Canvas

Osterwalder: Business Model Generation

A systematic approach for designing business models.

Gassmann et al: Business Model Navigator

A detailed explanation of 55 business models

Cusumano et al: The Business of Platforms

A comprehensive examination of digital platform businesses and how to build them.

Christensen: The Innovator's Dilemma

The classic that coined the term "disruptive innovation".

Moore: Chrossing the Chasm

A timeless classic of product strategy, focusing on how products go from early traction to conquering mainstream markets.