What is Business Model?
A business model summarises the essence of an enterprise and reflects its core business idea. It defines the structure of value creation, processes and delivery as well as the mechanism of an enterprise. The model is simply a description of what an enterprise is going to do and how it is going to do.
In other words, a business model states processes, methods, mechanism, structure and operations that an enterprise incorporates to generate revenue.
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Business Model Definition
The following are some popular definitions of a business model:
According to Joan Magretta, “a business model is the story that explains how an enterprise works”.
According to Peter Drucker, “a business model answers the questions to who is your customer, what does the customer value, and how do you deliver value at an appropriate cost?”
A business model can be represented in the form of flowcharts and data diagrams so that it can be easier for individuals to understand the processes and functions of an enterprise. A business model can be simple or complex, depending on the nature of an organisation’s business.
For example, the business model of a movers and packers company will be simple as compared to that of a telecom service company.
Mark W. Johnson, in his book, ‘Seizing the White Space: Business Model Innovation for Growth and Renewal’ proposed a four-box business model. This model works as an effective tool to structure a business model by highlighting the interaction between customer value proposition, profit formula, key resources and key processes.
Four-box Business Model
Let us discuss these four basic elements of the four box business model as follows:
Customer value proposition
A customer value proposition describes the experience and values that a user would get after using a product. Traditionally, organisations believed that customers usually buy what producers produce. Thus, these organisations did not believe in quality, features or style. This notion is reflected in the concept of mass marketing. However, this belief is not applicable in today’s competitive era where people have a number of choices to make the most suitable selection.
At present, an organisation is required to deliver products in accordance with the needs of the target customers so that they can derive maximum value from the purchased products. Some organisations use the word ‘realisation’, which is a formal term used for the value that customers get out of what they buy.
The customer value proposition creates a foundation for realising how a product will be valued by the target user. It evaluates advantages and disadvantages that a target user would experience after using a product. The sum of all these experiences helps an organisation to determine the value of its products in its market.
It is the next important element in the business model. Profit formula refers to a method that a business employs to identify how it will produce value for its shareholders as well as customers.
A significant component within the profit formula is the revenue model, which determines the price that an organisation should charge at a given volume of sales for covering fixed costs.
This helps an organisation to reach the break-even point and achieve any desired profit margins. While generating the profit formula, the following questions need to be answered:
- What are the profit margins that each market segment can earn?
- What is the revenue that can be produced for each product or market area?
- What fixed and variable costs would be incurred to produce sales?
- What are the main financial measures that can help to assess the business model?
For each target market segment, an organisation should examine each question and determine the degree of price sensitivity, the frequency, and the quantity of buying.
- Key resources: They include unique products, people, technology, facility, funding, brand and equipment. Key resources deliver the value proposition to customers. However, there are certain resources or a unique combination of resources that create a difference in between success and failure.
An organisation, in order to provide maximum value proposition to its customers, needs to identify and manage its key resources. For example, people are the essential key resources for any service delivery. Therefore, it becomes essential for an organisation to recruit employees with good skills and abilities.
- Key processes: They help an organisation to deliver customer value proposition in a sustainable and manageable way; develop an effective profit formula; and optimise key resources.
For example, customers walk into a fast food restaurant and get the meal delivered within a few minutes. The delivery of the meal involves the key processes of order taking, meal preparation and delivery. These key processes generate maximum value for customers. An organisation that successfully identifies its key processes distinguishes itself from its competitors.
Therefore, a business model is a representation of the actual business, its functions, their inter-relationships, interdependencies, and so on. It is usually represented in a graphical form using flowcharts and flow diagrams. Figure shows a business model and its practical application: