Business Model: What Is It, and Why Does It Matter?

Business Model: What Is It, and Why Does It Matter?

Running your own business is often a learn-as-you-go process. In other words, you can make mistakes and turn them into valuable learning opportunities. However, you must get a few things right from the start if you want to set up your company for long-term success. One of them is your business model. 

Many novice entrepreneurs will choose a business model impulsively before they have even studied its specifics, only to discover it’s not a good match for their product and audience. By the time they decide to do a revamp, competitors have already captured the market. Customers have become loyal to other businesses. It’s no longer feasible to operate. 

If you want to establish a business venture that is profitable and sustainable, you have to understand how different business models work – and implement the correct one from the beginning. We’re here to help you do just that. In this post, we’ll discuss what a business model is, cover its types, and explain how you can identify the best one for your business. 

what is a business model

What Is A Business Model?

If you google business model meaning, you’ll come across a wide range of definitions and interpretations. But they are all based on the same concept, i.e., a business model serves as the roadmap for how a company will make money with its product or service. Its essential components include a value proposition, a profitable niche market, and a revenue idea. The right model can help you figure out elements such as:

  • What problem are you trying to solve 
  • How will you create value for customers
  • What type of expenses you will incur 
  • How you intend to market your offerings 
  • What you can expect to earn in profits

Several new models have popped up since the internet made it possible to reach people in all corners of the globe. These models have enabled aspiring entrepreneurs to carve out space in the online marketplace.

For example, Canadian entrepreneur Alex Ikonn and his wife Mimi used Shopify to set up Luxy Hair – an online store offering remy human hair extensions. Luxy Hair follows the ecommerce model to make money where it markets and sells its products electronically. Various other business models exist, each of which can work for different businesses.

Luxy hair revenue model

Types of Business Models

After you come up with a business idea, think about how you will sell that idea to people. It’s easy to build a company, but making it successful requires a well-thought-out model fueling its growth. You don’t necessarily have to create an entirely new business model to make an impact. Instead, you could use an existing model and refine it for your industry. Below are the common types of business models that entrepreneurs use to start a business

1. Ecommerce business model

Ecommerce is all about creating an online store to sell physical and digital items. Suppliers are a vital part of streamlining operations in this business. You can find suppliers for almost every product nowadays, but identifying the reliable ones is where you need to focus your efforts. 

Going back to our example of Luxy Hair, the founder Alex went on the product sourcing website Alibaba and got in touch with various hair extension suppliers. In choosing his supplier, the decision came down to product quality and the suppliers’ communication style. The suppliers with the best communication and items won their business. Besides these two factors, you can take the supplier’s shipping time, production capability, and expertise in your product type into consideration. 

Pro tip: Buying an ecommerce business can save you the time spent on identifying high-quality suppliers. On Exchange, you’ll find many online stores that already have connections with reliable suppliers. Purchasing such a business means you’ll acquire a handy list of proven suppliers who’re ready to serve your store. 

2. Dropshipping business model

Dropshipping is similar to ecommerce, except that you don’t need to store or ship the products you sell. Rather, the suppliers you work with handle the inventory part of your business. They also store and ship the products for you. This means you’ll just need to create an online store, list products for sale, run a marketing campaign, and make sales. 

Tools like Oberlo have made the dropshipping model easy to implement. Not only do they allow you to find dropshipping suppliers to order products from, but they also automate the process of notifying the vendor when a customer places an order. Plus, you’re able to add the products you want to sell to your store in just a few clicks.

Many online stores use the dropshipping model to monetize their businesses. One example is Paint By Numbers. This Shopify dropshipping store sells DIY paint kits that make it easy to create beautiful artwork. The business currently brings in $10,000 in average profit each month, which is no small feat.

dropshipping model

3. Affiliate marketing business model

Affiliate marketing is when you endorse a product or service of another business and earn a commission on the referral. For example, blogger Ryan Robinson’s primary income stream is affiliate marketing. He mentions web hosting software and other helpful online tools in his blog posts. He also inserts referral links that take readers to the tool developer’s website. Readers who check out the tools sometimes end up purchasing them. In return, Robinson receives a commission.

The affiliate marketing model works best when you have a big audience to sell to. But it can also work for newer businesses if they’re able to get enough traffic. For example, many Instagrammers out there use creative posts and stories to attract people to their accounts. When they’ve generated a big enough following, they’ll sell affiliate products and services in their posts and earn a commission on them. 

You can use affiliate marketing on any platform that allows you to deliver content to your audience, such as blogs, social media websites, and emails.

4. Subscription business model

A predominant revenue model for online software companies, subscriptions require customers to pay a recurring fee to access a product or service. You can choose to charge them a fixed amount each month or use a pricing structure that allows them to sign up on a long-term basis for a lower fee. 

You can also segment your target market and offer certain items in your inventory under different prices and plans. For example, the workplace chat company Slack offers a Standard plan to SMBs for 6.67 USD per month and a Plus plan to larger companies for 12.50 USD per month. While content and service-based businesses typically use this model, it can also be lucrative for companies that offer a recurring delivery of niche products (aka. subscription boxes). 

The key to success with a subscription business is to provide enough value to customers so they keep renewing their plans to enjoy your product or service.

5. Franchising business model

You’re probably familiar with franchising – the process that chains like McDonald’s and Starbucks use to expand their businesses. The franchise business model allows you to acquire the rights to sell an established brand’s products in exchange for a royalty. The original business, or the franchiser, works with the franchisee on marketing, financing, logistics, and other operations to ensure the business runs as it should.

Securing a franchise brings some important advantages for the franchisee. You get access to processes, suppliers, and products that are already turning a profit for the parent firm. However, you have to strictly follow these processes, which means there is less flexibility for the franchise owner. That said, franchising removes the need to establish and grow a brand, as you already get a renowned brand to sell under.

Franchising is best for entrepreneurs who have a good chunk of startup capital and would rather sell under an established brand rather than creating one from scratch.

how does franchising work

Image credit: SlidePlayer

6. On-Demand business model

The on-demand business model requires companies to satisfy customers through the instant provision of services. An essential aspect of this model is knowing what people need and how they behave in the modern world. Ideally, customers should be able to access the services they need from their smartphones. For example, Uber allows people to request cabs and food deliveries in a few taps. Since it’s so convenient, it’s also a viable solution for customers that provides instant gratification. 

The interesting aspect of the on-demand model is that you don’t supply the services yourself. Instead, you create an online or an app-based marketplace where you aggregate suppliers whose services you trust. You then invite people to sign up for the marketplace and request services from the listed suppliers. On every service request, you take a commission from the supplier. 

So essentially, you connect two individual parties and earn from the transactions that occur between them.

7. Razer and blade business model

This business model involves selling a great product at a low price to generate customer loyalty and then profit by selling complementary products at a premium. Have you ever wondered why personal care companies charge more for blades than they do for razors? It’s not because blades cost more to manufacture– but because they want to make money selling them at a higher margin. They know that consumers will buy the blade after developing loyalty to their lower-priced razor. That’s how they earn a profit. 

If you have a great product with lots of pairable items, then the razor and blade model might be the perfect option for you. But if the product costs a lot to produce, you can use the reverse razor and blade model – where you offer the core product at a high price and then charge less for items that complement the main product.

The technology giant Apple is a classic example of the reverse razor and blade model. They sell iPhones and MacBooks at a premium, then upsell additional services, tools, and accessories that cost much less.

Apple reverse razer and blade

How to Choose the Right Business Model for You

As you can see, there are a variety of business models for you to pick from. However, you shouldn’t rely on intuition when deciding which model to implement. Below are the factors that should go into your decision:

Market potential

When evaluating a specific model, you must understand how you’re going to scale the business. Check to see how many companies are already using that model and how successful they are. Use their earnings reports and industry analysis to collect information on their performance. If the numbers are good, it’s a proven model that you can tweak to use for your own business. 

Costs 

Do you have enough funds to support the business model? For example, if you’re going to launch a subscription-based business, can you afford to hire a developer for 2-3 months? When selecting a business model, make sure to account for the expenses associated with its implementation. 

Value creation 

The model you choose must provide value to your audience. Customers are the lifeblood of your business, so you should put their preferences at the center of your decision. For example, if you’re implementing the on-demand business model, you might find that your audience prefers to chat with the vendors before requesting their services. In this case, offering a chat function in your marketplace can work wonders for your business. 

Business Model Template

Once you’ve selected the right model for your business, it’s time to define how you will implement it in your company. This is where a business model template or canvas comes into play. Initially developed by Swiss entrepreneur and business theorist Alexander Osterwalder, the template offers a visual representation of how the various elements of a business will work under a certain model.  

Here’s how it looks:

business model canvas

Filling out this template can help you identify the core activities and resources needed to make your business successful. You can also share it with your team (if you have one) to give them clarity about the required processes. Think of the canvas as a blueprint that structures your business initially – and you later refine it to adapt to new trends and market shifts.

Conclusion

A business model is an important tool for identifying the strategies that will help bring in profits. Using the tips and strategies mentioned above, you can identify the best profit-making strategy for your startup. When documented properly, your model can become a reference tool to help you stay on track with sales targets and other goals. Taking your time analyzing the different models will ensure you opt for something that you’re capable of implementing efficiently and effectively.

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