At the core of every successful company is a strong business model.
Your business model is the blueprint for how your business will make money (or not). But for many companies starting out, not enough time or effort is put into identifying the right business model for their business.
This can turn out to be a very costly mistake.
In a study by CB Insights on the top reasons why startups fail, a top ten reason (coming in at #7) is going to market with a product without a business model.
It doesn’t have to be this way.
Designing the right business model for your company, product and goals are very much in your control. From our experience working with fast-growing startups to global corporations, we cover core elements to building a successful business model.
What Is A Business Model?
Let’s level set by making sure we understand what a business model is, and is not.
According to John Elkington and Richard Johnson, “business models are what connects technology potential with real market needs and consumer demand”.
Another definition from management theorist Peter Drucker is that a business model is “assumptions about what a company gets paid for”.
So there are two vital parts to understanding what a business model means for your business:
- A connection between your product or services and the needs of your customer and market; and
- A structure that defines your customer’s willingness to pay.
This is important because to build the right business model it will depend on how much we know about our customer, market, value proposition, prices, and financial requirements and resources.
This requires information – the right information – to help us assess and inform the right business model for our company.
No small task, but all work within your control.
Why Your Business Model Is Critical To Your Company’s Success
Entrepreneurs and businesses understand that they need a business model, but too many do not understand what makes a good business model for their business.
A good business model answers core questions about how your business will operate, as well as the viability prospects of the company. A great business model creates a competitive advantage embraced by customers and differentiated to the competition.
Given the high stakes, your business model should not be left to guesswork and chance.
Create and deliver value: How you bridge the gap between your solution and customers
Why your customers need a new product – more specifically your product – is not always obvious. This is especially relevant for new technologies and innovations.
Your business model is the bridge between the solution your company offers, and the needs and willingness to pay of customers. It is how customers make sense of your value proposition and the pathway to acquiring the proposed solution.
Financial viability: How your company makes money
At the core of any business model is how a company intends to make money and profit from its products. The quality of the business model for a company and its product reflect whether enough money will be generated (read: profits) to achieve viability.
The business model also reflects how well the company understands its customer and market, to make a commercial enterprise capable of generating revenue and eventual profits. If the business model isn’t right, this can wreak havoc on the financial viability of your company.
Strategy: How your company wins customers and the competition
Too many companies – big and small – have a tendency for a ‘follow-the- leader’ mindset when selecting a business model. This can be an actual market leader with a commanding market lead and is setting perceptions on the value and prices.
Then there is the perceived market leader, where within an industry – often in nascent or technology-driven industries – there are companies competing with one another despite the vast majority of prospective customers don’t know the company let alone the value proposition or pricing competitors.
What this means is there is business model complacency that occur for many companies, leaving potential profits on the table, but also a missed opportunity to differentiate from competition. By creating business models that are like everyone else, there is greater pressure to justify the value proposition and the pricing question of “is it worth it?” – a tall order for many startups and new ventures.
Key Components Of A Business Model
Like pricing, a good business model doesn’t start by simply selecting between a menu of models. No, a good business model starts by understanding your customers for your product created by your company. A great business model is designed for the company, it’s customers, and the goals the company aims to achieve.
Your value proposition
Developing an effective business model requires a clear identification of the value proposition and how you can differentiate yourself in an often-times crowded market.
As Peter Drucker famously says, ”Customers don’t buy products, they buy the benefits that these products and their suppliers offer to them.”
We often take for granted what our product actually does for our customers, leading to business models built on assumptions. Companies that are attempting to disrupt an industry, are particularly prone to this because they hold the belief that the disruption itself is the benefit.
Yet human nature is often resistant to change if not rejects change outright in favor of the familiar. That’s why when you go to the purchase page of some software companies you see a long list of features and benefits – a list made for everyone, and thereby for no one.
The process of defining the value proposition and the benefit your product aims to deliver, the next question is, “who is the benefit for?”.
In our project experience working with companies from high-growth startups to large market leaders, the question of who is actually the company’s customer is commonly overlooked.
We take a tiered approach to the customer question that is based on the degree of connectedness the customer segment has with your product.
Imagine a series of concentric circles – like the rings of a tree trunk – where each circle gets smaller as you get closer to the center. While in aggregate, all the circles combined represent your desired market, it is those circles closest to the center that care most about your product and ideally, your brand and company.
Defining who those customers are, what they value most and the benefits they need to derive – whether through your product or a different solution – is critical. This enables you to create a business model aligned to your customer; not someone else’s customer.
The best companies are pricing experts because one of the most important parts of your business model is the pricing strategy.
An effective pricing strategy maximizes revenue and demonstrates that you really understand how your customers value your offering. The amount of resources dedicated to developing a pricing strategy also reflects how much time a company has spent trying to extract value out of its products. This involves monetizing different aspects of the product to serve the largest possible audience.
More advanced pricing strategies may use tools such as targeted discounts or promotions to increase revenue, and the use of other pricing design tactics. A good pricing strategy that captures the value out of your offering increases the odds that your business will be sustainable in the long run.
Your goals and resources
Creating a business model for your customer and company means self-discovery by your company of what it wants and needs to achieve. This can be to maximize revenue. It can be to penetrate the market and win market share. Creating a proxy for success steers how the business model is designed but also make changes as needed.
Creating a good business model also needs to account for resources needed to achieve your defined success. This may mean to make changes on how your company sources materials or talent, how your company acquires customers or shifting the business model.
When companies adopt a business model of market leader or look-a-like company, many input and output assumptions are made often to the detriment of the company. Rather than methodically evaluating inside on what is and is not available, attempts are made to fit their square (the company) into a circle (competitor’s business model).
Building The Right Business Model For Your Company
The types of business models available to you depend on the results of your work on the different components outlined above. This means a great deal more time spent on research and discovery as it is on selecting from a menu.
Even businesses that look similar at first glance could have dramatically different business models. Consider video game developers such as Electronic Arts and Epic Games. Electronic Arts have a traditional gaming business model and charge $60 per game up front. Epic Games uses a “freemium” model where games such as “Fortnite” are free to download and gamers then pay for in-game upgrades.
This has proven to be an effective strategy as Fortnite earned $300 million in April 2018, almost six times the first-month sales of EA’s highly anticipated Star Wars Battlefront II. Epic Games’ business model requires the company to engage customers over an extended period of time but Electronic Arts just need to make that first sale. Their respective business models don’t exist in a vacuum and are designed to achieve commercial objectives
It is also important to be mindful of potential pitfalls when building a business model. If the price is wrong, the analysis that follows will be fundamentally flawed. Targeting the wrong customers means that the business model will emphasize the wrong product attributes. Every assumption in a business model needs to be checked and rechecked.
A company’s business model is a key success factor in both the short- and long-term.
A good business model identifies the core customer, their pain points, and how specific products or services can address those issues. The best and most disruptive companies create not only amazing products but a business model that connect paying customers to their solution.
But success comes not only through the ultimate model these companies chose, but the fact that the model was uniquely their own, for their product and customers.
Business models might serve as a blueprint for a company’s future but those plans aren’t static. Business models evolve over time as companies better understand their customers, the value of their offerings, and their competitive positioning. Evolution doesn’t necessarily mean a complete overhaul. It is a commitment to making actionable adjustments (e.g. pricing, product offering) that meet the needs of the market for now and beyond.
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