How to Think Through Your Business Model

You’ve probably heard people throw around the term “business model” so frequently and so casually that it has started to sound like just another example of business gobbledygook that doesn’t really mean anything.  We sympathize, but today we want to convince you not only that the term does in fact have an important meaning but also that it’s very relevant to you no matter what type of business you run.

Since at Haven we try really hard to avoid business gobbledygook, here’s our definition of what a business model is:  It’s a concise explanation of how a business acquires and pays for resources to provide a product to its customers and captures enough revenue to make the whole process worthwhile.  Not too gobbledygooky, right?  Well, just in case, let’s simplify it even further:  Your business model is how your business makes money from whatever it is that your business does.

Unfortunately, your business model itself probably isn’t as simple as our definition of it.  That’s because a business model has lots of different interlocking pieces.  When you describe your business model, it isn’t enough to say, “We’re a landscaping company,” or, “We’re a doctor’s office,” or, “I run an ecommerce website.”  Instead, try something more along the lines of, “We offer such-and-such a benefit through these channels to build these types of relationships with these types of customers.  We charge them in this particular way to make this amount of money from each transaction.  In order to do that, we need to acquire these types of resources from such-and-such a supplier to conduct these types of activities.  The costs associated with doing all of that are blahbiddyblah.”

Poetry, right?

To look at all of the moving pieces in that mess, let’s turn to our old friend, the Business Model Canvas, which, as the name implies, is a tool to help you visualize your business model.  We’ve written about the Business Model Canvas before when we were warning against letting the writing of a business plan become a gating item for actually starting a business, and we go into more of its history there, too.  But the upshot is that these days, the Business Model Canvas is popular among startups because it helps them analyze what components of their business model to change and swap out while they’re trying to find a business model that works and is actually economically viable over the long term.

But that’s not all it’s good for, not by a long shot.  It’s also good at helping existing, established businesses think through and understand their business models.  And why might you want to do that, you ask?  If it’s working, then why mess with it?  Because a business model is like an engine, and it can break down over time.  Doing a checkup every so often can help you make sure that all of the parts are still working correctly.  And every once in a while, you might also discover that even though one of the pieces is working just fine, there’s a fancy new piece on the market that might perform a lot better, so it might be time for an upgrade if the price is right.

Let’s go through each of the core pieces:

1. Value Proposition

Your business’s value proposition is the total package of benefits that you offer your customers through whatever products and services you offer to meet their needs.  We sometimes group value propositions into two big buckets:  those that are trying to help customers realize some gain and those that are trying to help them eliminate some pain.  The distinction can sometimes get a little fuzzy because if someone eliminates one of your pain points, then you probably feel like you’ve gained.  (Good ol’ addition by subtraction.)  Still, it does help make the point.

For example, if your customers are businesses, then you might sell a solution that helps them generate more leads, get better information about their customers, or close more sales.  Clear gains.  Or you might sell a product that’s more efficient, lasts longer, or is more reliable, ultimately leading to lower costs.  Eliminating pains.  Or if your customers are consumers, you might sell consumer products that are newer, more performant, more customizable, or better able to convey status.

2. Customer Relationships

Whatever you’ve decided that you’re selling, your value proposition has to be consistent with the types of customer relationships that you build.  Those customer relationships will encompass how you get new customers, how you retain them, and how you increase your share of their wallets over time by selling them more of your products.

What does that look like in your business?  Do you acquire customers by word-of-mouth, B2C social media advertising, channel partners, or enterprise sales?  Once you have a customer, do you provide a lot of high-touch hand holding or do your customers basically buy through self-service?  Once a customer is buying from you, do you only sell the same thing to them over and over or do you have the opportunity to upsell them into something with a higher price and better margins?

3. Channels

Whatever your value proposition happens to be, it isn’t enough to just have a good idea that a customer might value.  You actually have to deliver it, and you’re going to do that through one or more defined channels.  A channel is basically just how you get the value to your customers.

For example, if you’re in the grocery business, then your channel is probably a good-sized brick-and-mortar store (unless you’re a massive online grocery delivery business, in which case your channel is virtual).  Or if you manufacture a product, then your main channel might be distributors who pick up your product and get it into the hands of retailers.  Or you might rely on your own internal sales team.

At this point, we’ve only gone through three of the nine pieces of the Business Model Canvas, and you can already see how each piece raises lots of different questions and gives you the opportunity to make a lot of custom choices.  In that regard, a business model is a little like DNA, each of a business model’s pieces are like types of genes, and the choices you make are the specific genes that give you brown eyes or blue.  There are tons of different combinations, and different combinations might be better suited to the environment at different times and under different conditions, so you always want to be scanning your market and thinking about whether you need to make any changes to adapt.

4. Customer Segments

At this point, you might be thinking, “Okay, I know what my value proposition is, I know what types of customer relationships I want to establish, and what channels to use to get there, so now it’s time to go take over the world and sell to everyone!”  Well, not so fast.  As Abraham Lincoln once said, you can please some of the people all of the time, all of the people some of the time, but you can’t please all of the people all of the time.

That might sound like just some good homespun wisdom, but there’s some legitimate business logic behind it.  Different customer segments, whether you split them out by education, income, sex, or just basic product preferences, are going to want different things, and you may need different channels to reach them, and you may have to do different things to keep them happy.  That’s going to divide your focus, and you’ll run the risk of not making anyone happy.  So try to divide the market into definable segments and then pick the ones that work best with the rest of your business model.

5. Revenue Model

If you’re creating genuine value for your customers, then you need to capture some of that value for yourself in the form of revenue in order to stay in business.  The particular way you charge your customers as you earn revenue is your revenue model.

As you might expect at this point, there are lots of different revenue models that you could implement in your business.  For example, you could charge a fee, either at the point of sale or after the fact through an invoice, in exchange for selling a physical product to your customers.  But perhaps your customer doesn’t want the higher upfront cost of acquiring a big-ticket item.  Then you could lease them the right to use the asset in exchange for leasing payments over the leasing period.  (Licensing fees for nonphysical assets in which you hold intellectual property work in a similar way.)

If your offerings are services, not physical products, then you might charge a user fee each time you perform a service for your customer.  As a variation on the user fee, you could charge a subscription fee on an ongoing basis for continuous access to an ongoing service.  Or if you’re bringing two other parties together so that they can engage in a commercial transaction, then you might charge a transaction fee on each transaction in which they engage.

6. Key Activities

Everything we’ve described so far is very customer-facing.  But there’s a whole lot of sausage making that the customer never sees, and those key activities are a very important part of your business model because they basically are how you create the value that you then try to deliver to your customers.

For example, if you’re a manufacturer, then supply chain logistics for acquiring materials, parts, and supplies and the actual assembly are pretty key activities that you need to be able to do really well.  If you’re a restaurant, then you have some similar key activities in terms of acquiring food products and preparing them in the kitchen, but you also perform an additional key activity in the form of on-premise service for your guests.

When you pop the hood to take a look at your business model, ask yourself whether you’re conducting these key activities in a manner that aligns with your strategy and your brand.  If you’re trying to offer your customers the lowest-cost alternative in your class, then you can’t afford to platinum-plate your internal operations.  Efficiency is the name of the game.  But if you’re offering a luxury product, then your considerations are going to be different, and you will likely want to have a higher cost structure to appeal to your preferred customer segment.

7. Key Resources

Your key partners are important because they’re your source for all of the key resources that your business needs to create value for your customers.  In accounting-speak, these resources are assets that your business acquires and then uses to generate revenue.  For example, these resources could include financial assets, like the capital that you need to finance your business, or physical assets, like the materials and inventory that you need to have on hand, or intangible, like intellectual property or contractual rights.

When you’re thinking about your key resources, your first step is to get a grasp on all of the resources that you actually use and understand the relative importance of each.  The second step is to make sure that you can acquire them when and as you need them.  If there’s one particular key resource that really drives a lot of customer loyalty, then jealously guard your access to it and be on the constant lookout for backup sources.  And over time, make sure you understand which resources are no longer quite as key as they once were because that will allow you to cut unnecessary costs.

8. Key Partners

No man is an island, and neither is a business.  No matter what space you’re in, you’re going to interact with others in the market who aren’t your customers and aren’t your competitors, either.  The ones who help you are your key partners.  They could be suppliers, distributors, service providers, or maybe even other businesses whom you work on a special project with from time to time.

Think of your key partners like a portfolio, and make sure that you review it from time to time.  Is a particular supplier letting you down?  Then test the market and see who else is out there.  Worried that one supplier accounts for too high a percentage of your cost of goods sold?  Then think about diversifying your sourcing.  Is there a form of advice that no one in your network seems to be able to give you, leaving you feeling like you’re flying blind?  Then there’s probably a completely empty chair at the table, and it’s time to start asking around to see who could possibly fill it.

9. Costs

We saved your favorite part for last, and that’s your cost structure.  Costs are an inevitable part of any business, and they need to be managed.  The first step is to understand what your cost structure looks like.  For example, do you have to incur high fixed costs just to get a seat at the table?  Or are your initial fixed costs low but your variable costs pretty high?  These factors are going to determine whether you enjoy economies of scale and how easily your business can grow.

As with everything we’ve discussed so far, your cost structure isn’t something that you can determine in isolation.  It has to fit with the other pieces in your business model.  We’ve presented these pieces in a pretty linear numbered list because, well, that’s pretty much how you write these things, but keep in mind that a business model is like a bunch of little feedback loops all rolled into one.  When you change one piece, it’ll affect some other piece somewhere else.  So just like the proverbial guy in the garage, you’ll always want to be tinkering with it, experimenting to see what works best.