An office conference room neatly organized.
In its most basic terms, a business model is an explanation of how your business operates and makes money. When the first Walmart opened in 1962, their business model was to offer customers department store products at significantly lower prices, by removing amenities such as chandeliers, carpeting and personal service. An effective business model addresses all aspects of your business, from the value you provide to your customers to how you will deliver your product to them, and shows how all these pieces work together to earn a profit.
Business Model Questions
Understanding business models and designing your own begins with answering the following questions:
What problem are you solving?
In order for your business model to be viable, you must be solving a problem for your customers or tapping into an unmet need in the market. Determine what that problem or unmet need is, and test your idea to verify that it is one that is in demand and will therefore be profitable.
Who is your target customer?
Conduct market research to focus in on your target customer and find out who they are (age, gender, income level, etc.), what they value, and how you will attract them. The more you get to know your customers and what they want on a deeper level, the more you can tailor your product or service to meet their needs.
How will you generate revenue?
This includes the products and services you will offer, as well as how you will deliver them to your customers. How will you purchase supplies and manufacture your products? Where will you sell them? What are your costs, and how much will you charge for your product or service? The key is to keep your costs low enough to make a profit, but high enough to create a high-quality product that will provide value to your customers.
How will you finance your business?
Determine your startup and operating costs, assess how much money you are able to invest personally, and then find out where the rest of your funding will come from. Will you take out a business loan, seek venture capital or use crowdfunding? If you borrow money, who will you make payments to and for how long?
Types of Business Models
According to analyst and business model strategist Eric Noren, there are four main types of business models:
With this model, the business owns an asset and charges others to use it temporarily. This can be physical assets like a house or car, intangible assets like financial services, or intellectual property, such as trademarks, patents and copyrights. Zipcar, Hilton Hotels, JPMorgan Chase & Co. and HBO all use this type of business model.
Creators include anyone who invents or designs a product to sell, whether it’s furniture, computer software, clothing, books, artwork or online content like graphic design or copywriting. Apple, Tommy Hilfiger and Stephen King are all examples of creators.
Builders are those who manufacture products that someone else has invented. Examples include Honda and Foxconn, the company that assembles products for many creators such as Apple, Acer and Dell.
Sellers include anyone who sells a product or service, such as retailers, wholesalers, distributors or subscription service providers, including Walmart, Amazon and Netflix. Brokers, who connect people with products or services, are also included in this model, such as Airbnb, eBay and RE/MAX.
In addition to a business model, you must also have a business plan that details how you will execute it, such as the equipment and staff you will need, your marketing plan, your financial projections and how you will stay ahead of your competition.
Keep in mind that your business model may change over time. For example, when EuroDisney opened, they assumed that their European customers would behave the same way their American customers did, by grazing for a long time at restaurants and spending the same amount of money on food, rides and souvenirs. In reality, the European customers all expected to be seated at precise times during meals, leading to long lines and unhappy customers. It took changing several aspects of their business model before EuroDisney became a success.
As Joan Magretta writes, “Business modeling is the managerial equivalent of the scientific method—you start with a hypothesis, which you then test in action and revise when necessary.”
Understanding business models, collecting the right information, and answering the right questions will help you be successful as an entrepreneur. Be sure to build your model.
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