LP Business Model
A business model is an abstract representation of an organization. It gives an understanding of the problem you are solving, who are your customers, who will you work with, how will your business operate and how will you make money and what will it cost to make money. More than anything else, it reflects on the viability of your business.
Every company’s business model consists of two components.
Revenue Model: Your revenue model will show how you will earn or generate income from your business. Suppose you own a bakery. Your basic revenue model will separate breads and cakes into two sources of revenue. However, you can take it further and break the revenue model into in-shop sales and party orders or according to type of dessert and breads (e.g. French, Italian etc.). Breaking down the model can help identify which category is generating more revenue and how revenue can be increased in each.
Cost structure: Costs are basically the money you would need for your business. These would include costs of producing your product or providing your service and operating costs. As with revenue, you can also categorize your costs and try to understand how you can reduce it. Now, let us look at a structured way to understand the business model.
Introduction – Business Model Canvas
According to Business Model Generation by Osterwalder & Pigneur , the business model consists of nine building blocks. These blocks are Customer Segments, Value Propositions, Customer Relationships, Key Activities, Key Partners, Cost Structure, Revenue Streams, Distribution Channels, and Key Resources.
Revenue Streams represent the money a company generates from each customer segment. In a simple formula, it is represented as:
Earnings = Revenue-Cost
Revenue Streams answer what and how the customers would pay for your product or service. Some companies have a set list price such as a restaurant in your city. Some might have volume dependent pricing such as wholesalers, who sell products only in bulk, thus depending on the quantity, they set the price. Some might have prices varying depending on the market such as jewellery businesses. Some might have feature dependent pricing, such as similar models of phones and laptops have different prices depending on features such as storage capacity. Some companies might have auction-based pricing.
An extremely interesting example of this was when brands had to bid to put advertisements on Pinterest, which challenged Google Ads in a way. Revenue may be earned rather by a one-time payment made by the customer or by recurring payments made by them. A few examples of common revenue streams are:
Unit or Asset Sale: This basically refers to deriving revenue by giving ownership rights to someone else for a product. Tata sells cars and it is up to the buyer to drive, resell or scrap it.
Usage Fee: This revenue stream is generated by the use of a particular service. A hotel gets its revenue depending on the number of the nights a guest says.
Subscription Fee: In this, revenue is generated by giving continuous access to a service or a product. Gym membership and everyday newspapers are a few simple examples of this revenue model.
Franchising: Franchising is a practice where a company gives the right to use its business model and brand for a prescribed period of time. The company can earn in different forms of payments such as royalty for the trademark, fee for training and advisory services, percentage of individual business unit’s sales etc. Mc Donald’s is one the largest franchised chains in the world that makes all its revenue through this revenue stream.
Lending/Leasing/Renting: This revenue stream is created by temporarily granting someone the exclusive right to use a particular asset for a fixed period in return for a fee. Boeing started a subsidiary company that offers aircraft leasing to various airline companies. Zoomcar is a company that helps people rent cars for self-driving.
Advertising: This revenue stream results from fees for advertising a particular product, service, or brand. Traditionally, the media industry and event organizers relied heavily on revenues from advertising. In recent years, companies such as Spotify (Audio Ads), Google (Search Ads), Snapchat (Content Ads), Commonfloor (Property Ads), YouTube (Video Ads) have used this revenue stream.
Licensing: Licensing refers to granting permission to use protected intellectual property in exchange for licensing fees. Licensing allows rights-holders to generate revenues from their property without having to manufacture a product or commercialize a service. Microsoft and Adobe charge a licensing fee for their products.
Commission/Brokerage Fee: This revenue stream derives from intermediation services performed on behalf of two or more parties. Businesses that match the supply and demand side of anything. For example, Ola earns its revenue by charging a commission from the car owners who choose to drive on the platform and give a ride to people who request a ride using the ap
Customer Segments refer to the different groups of people or organizations an enterprise aims to reach and serve. When building a business, the first thing to understand is who your customer is. A business can only be profitable if there are people out there willing to buy what you are planning to create. Businesses cluster customers based on demographics, psychographics and common needs, behaviours, expectations and desires. Once it is clear which of the different segments exist in the target market of your business, you can design and prioritize your business activities according to specific customer needs.
Example: Aman has an e-commerce website that sells men’s and women’s formals. The core target market is working professionals between the ages of 22-50. The website also has an option of customization for formal shirts where customers can choose the colour of the collar, pocket, buttons and other designs. Aman has built a tracking system that compiles the data based on who opened and used his website. Thus, he segments his customers based on first-time visitors vs. repeat shoppers, registered users vs. guest users, last buy within one month vs. six months vs. one year, top purchasers, location, device type (mobile, tablet, laptop)and personal data (gender, income, style preferences etc.). This helps Aman cluster similar customers together and send them emails about new products and offers according to what they bought in the past
Value propositions refer to how you describe your product or service to the customer. It gives a compelling reason for the customer to purchase it. Value proposition is the reason why customers would choose one company or brand over another. It is an aggregation, or bundle, of benefits that a company offers customers.
Channels refer to the mediums or means used to communicate with and reach the customers. These include communication, distribution, and sales channels through which customers get the information and delivery. An organization may choose to reach the customer through various channels such as:
Owned channels such as salespeople employed by the organization
Retail stores owned and operated by the company
Own website and in-house customer support centre
Partner channels such as wholesalers, retailers, e-commerce websites, app stores, dealers, agents, franchisers, brokers, outsourced call centres etc.
Partner Channels lead to lower margins, but they allow an organization to expand its reach and benefit from partner strengths. Owned Channels and particularly direct ones have higher margins, but can be costly to put in place and to operate. The trick is to find the right balance between the different types of Channels, to integrate them in a way to create better customer experience, and to maximize revenues.
Customer relationships describe the types of relationships a company establishes with specific customer segments. Companies maintain relationships with customers with the objective of acquiring new customers, retaining existing customers and in turn boosting sales. Companies might do this in various ways.
∙ Give personalized assistance through call centres and emails or might even dedicate an employee of the company to handle a client or customer account personally. ∙ Automate the customer support service or make it a hybrid of automated and personalized assistance.
∙ Choose self-service where the company does not maintain any direct relationship with the customer.
∙ Create communities where users can discuss a product or post their demands, solve each other’s problems and share their opinion about a particular topic. This helps companies analyse what the users want and create products accordingly.
∙ Engage the customers by making them create something for other customers. For example, online platforms such as Youtube.com, Wikipedia, and Medium solicit customers to create content for public consumption. Various e-commerce websites encourage customers to write reviews. This helps other customers understand the pros and cons of a particular product or service.
Key Resources refer to the most important assets required to make a business model work. These are usually divided into physical such as land, building, transportation, warehouses etc., human such as labour, workforce, salespeople etc., financial such as cash, working capital, stock, equity or debt financing etc. and intellectuals such as brands, proprietary knowledge, patents, copyright etc. Every business requires key resources. These resources allow an enterprise to create and offer their product or service, reach markets, maintain relationships with customer segments, and earn revenues. Different resources are needed depending on the type of business model. Key resources can be owned or leased by the company or acquired from key partners.
Key Activities describe the most important things a company must do to make its business model work. Every business model calls for a number of key activities. These are the most important actions a company must take to operate successfully. Some common activities include production or manufacturing of a product based company, software and problem solving for service based businesses and online website or app or online portal for most businesses. Like key resources, key activities differ depending on business model type. For software maker Microsoft, key activities include software development. For car manufacturer Toyota, key activities include production management. For consultancy McKinsey, key activities include problem solving.
Key Partnerships describe the network of suppliers and partners that make the business work. Companies forge partnerships for many reasons, and partnerships are becoming a cornerstone of many business models. Companies create alliances to optimize their business models, reduce risk, or acquire resources in an optimal way.
If you want to start a company that makes backpacks, you will have to find suppliers who sell fabric that you choose such as nylon, cloth etc. and zippers and Velcro etc. Sometimes companies form strategic partnerships with non-competitors through which two brands can be mutually beneficial. This helps them leverage the power of brands. For example, Uber partnered with Zomato such that a customer could think about booking an Uber while using the Zomato app. Thus, if you are looking at going to a restaurant on Zomato, you can see how far an Uber car is and this in turn would remind you to just book it instantly rather than think about taking your car or going to the Uber app and booking. Some companies also form strategic alliances with competitors. Qatar Airways and British Airways got into a joint business agreement to offer both their customers a more seamless travel experience. Sometimes entrepreneurs choose to start a joint venture to develop a new business. For example, Starbucks entered into a joint venture with Tata Group to expand its market to India.
An organization’s cost structure includes all costs incurred to start the business and operate a business model. Business Models can be divided in various ways based on the cost they incur. Let us first understand the difference between fixed cost and variable cost. Fixed costs remain with the business despite the number of goods or services produced. On the other hand, variable costs change proportionally depending on the number of goods or services produced. Manufacturing companies such as automobile companies, metallurgical product companies have higher fixed costs rather than service businesses. Some businesses are cost driven while others are value-driven. This means some focus on minimizing their costs and offer low price value propositions. For example, Dell computers focus on being low cost and thus do better for corporate customers than Apple macs. On the other hand, some businesses are less concerned with the cost implication and focus on creating value. For example, luxury hotels are more value driven
Activity: Business Model
When: during session
How: Fill the business model canvas for your business idea
1) Which of the following is the correct formula for calculating “Earning”?
a. Revenue – Cost
b. Cost – Revenue
c. Revenue – Loss
d. Loss- Cost
2) Which of the following is not a part of the Revenue Stream?
3) What is the role of Revenue Structure in Business Planning?
a. Various ways to generate revenue
b. Sources of revenue generation
c. Willingness for customers to pay
d. All of the above
4) Which of the following is not a part of Business Model Canvas?
b. Cost Structure
c. Business Expansion
d. Revenue Streams
5) What is variable cost?
a. A fixed cost
b. A cost that changes proportionally
c. A minimized cost
d. An occasional cost