Business Models For Dummies
Overview
Write a business model? Easy.
Business Models For Dummies helps you write a solid business model to further define your company's goals and increase attractiveness to customers. Inside, you'll discover how to: make a value proposition; define a market segment; locate your company's position in the value chain; create a revenue generation statement; identify competitors, complementors, and other network effects; develop a competitive
strategy; and much more.
- Shows you how to define the purpose of a business and its profitability to customers
- Serves as a thorough guide to business modeling techniques
- Helps to ensure that your business has the very best business model possible
If you need to update a business model due to changes in the market or maturation of your company,Business Models For Dummies has you covered.
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About The Author
Jim Muehlhausen is the founder and President of the Business Model Institute as well as consultant and speaker to businesses large and small. He is the author of The 51 Fatal Business Errors and How to Avoid Them and a frequent contributor to Entrepreneur, Businessweek, and dozens of other publications.
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business models for dummies
CHEAT SHEET
Designing or updating your business model becomes easier when you think through your offering, monetization, and sustainability. As you work on your business model, keep important tips in mind, ask questions to stay on track, and browse different pricing models to determine what's best for your business.
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At the core of a great business model is the ability to generate superior profits. In order to generate the superior profits, you need to create a profitable revenue model. A profitable revenue model has two components:
Your revenue model should generate high gross margins.
The total gross margin generated needs to exceed your operational or overhead cost.
You don’t need a unique offering in order to have a business model. If, however, you want to have the most successful model possible, you want to offer customers something they can’t get somewhere else.
This uniqueness may be only one thing, such as the sole gas station on a particular corner, or it may be a combination of product and service features, such as those in a Lexus automobile.
General Business
If your business plan includes the need to borrow money constantly, it is probably not a good one. For example, sales are increasing 30 percent per year. Your accountant informs you that you’ve produced nice profits for several years, but you never have any money in the bank. In order to fund your growth, you’re in constant need of borrowed funds.
General Business
A business counseling client once said, “If I didn’t own this place, I’d quit.” Because the business owner can’t quit, many business owners use the hope of selling their business as the universal magic wand to fix their frustration.
Often, a business owner has been slaying the dragons of his everyday business for years only to wake up the next day and find a different dragon.
A business model that says, essentially, "I used to work for a company that did the same thing," is not something investors want to hear. This plan has a good and a bad aspect — the bad part is a successful company is already using this business model. Without significant change to the model, why bother?
The good part is a proven business model and management that understands the model.
Designing or updating your business model becomes easier when you think through your offering, monetization, and sustainability. As you work on your business model, keep important tips in mind, ask questions to stay on track, and browse different pricing models to determine what's best for your business.
General Business
Great business models are built upon great margin. What does it say about your business model if your competitors’ margins are better than yours? It’s not the end of the world, but it certainly means you’re climbing at a steeper grade than your competition.
Decreased margin puts you at a significant disadvantage vis-à-vis your competition.
General Business
One big issue with a business model can be with sales. Here are some of the most common scenarios seen with mid-sized and small businesses concerning issues with their business model:
Employing a small sales team that produces mediocre results
The business owner is the top performing salesperson by a wide margin
A history of hiring salespeople with great hopes they will be the “chosen one” who can sell significantly better than the others
Continuing to look for the elusive sales superstar who can outsell the owner
Hiring a sales superstar is rarely the answer to this issue.
General Business
One problem you might find when looking over your business model is one of delegation. Most business owners work below their pay grade. They know they should delegate work, but they don’t. These are the five primary factors at work:
Money: The work doesn’t get delegated because you can’t afford to pay someone to do it.
Most business models have customers that are neither exceptionally attractive nor exceptionally unattractive. Most business models don’t need to focus on customer attractiveness for long because the old mantra “all customers are good customers” is true most the time. However, you do have to study customer attractiveness.
A business model is like a lump of clay that you can mold into many different shapes and sizes. This pliability is a powerful feature, enabling entrepreneurs to craft their models to fit their business needs. Yet, despite all this potential for variety, all business models have a set of shared characteristics.
General Business
The goal of any great business model is to have a high-profit product that customers want to buy. A highly marketable product is traditionally described as having a unique selling proposition. Whole Foods offers only healthy choices in its stores. Domino’s Pizza grew rapidly because of its super-fast delivery.
General Business
Competitive advantage enables a firm to perform at a higher level than others in the same industry or market — or with anyone competing for the customer’s limited budget. Competitive advantage can serve as a powerful catalyst for your business.
Competitive advantage enables you to outsell, outprofit, and outperform others in the same industry or market.
General Business
Investors looking at promising business models often don't want to hear, "Everyone needs this product." When investors hear, “Everyone needs this product,” they may get the impression that you don’t understand your market.
The Gentle Ear Wax Vacuum Cleaner removes water and gunk from your ears via a battery powered, hand-held vacuum that you insert into your ear.
A business model plan combines the components of a business plan with business model analysis. This document augments or substitutes for the traditional business plan and has the following basic layout:
Background: Follow the traditional structure of the business plan for this section.
Breakdown of the business model into the crucial areas:
Market attractiveness
Unique value proposition
Profit model
Sales performance
Ongoing competitive advantage
Innovation factor
Avoidance of pitfalls
Graceful exit from the business
Operational overview: Follow the traditional structure of the business plan for this section.
When a company has a meaningful cost advantage, it has contrived a business model that’s more efficient than the competition. If you’ve ever had to compete with a company that can deliver the same thing as you for less, you’ve experienced the power of a meaningful cost advantage.
This cost efficiency can be leveraged in the form of lower prices to the consumer in order to gain market share, to build a war chest to ward off competitive attacks, or in the form of higher margins.
Pay attention to how many of your competitors have a similar unique selling proposition (USP). When Crest toothpaste first entered the market as the only cavity protection option, the USP was extremely powerful. Many competitors adopt what markets refer to as the “me too” strategy.
They put little time, money, or effort into identifying or developing niche markets.
It’s possible to create a strong selling proposition and value proposition but not create a powerful brand. The Newton by Apple had both a strong USP and UVP but failed to create a good brand for Apple. Part of your goal in creating a great business model should be to create a powerful brand.
All companies and products have a brand.
The most profitable industrial product of all time is the Xerox copier. During the 1960s and 1970s, margins on the product were obscene. The copiers were so profitable that Xerox quickly determined that selling the copiers was a bad business model, because the entire cost of the copier could be paid off in a few months of rent.
General Business
Having the right product mix can be an important component of your business model. Most businesses have several product or service offerings. Some of these offerings have low gross margin, some have high gross margin. A business model that can successfully sell more of the high-margin items is significantly better than a business model that sells only the low-margin items.
The unique value proposition (UVP) extends the concept of the unique selling proposition (USP) to include the benefits derived by the customer. Customers ask themselves, “Are the unique features of this product worth the price?” Customers engage in this features–value weighing for all purchases. Augmenting your USP with a strong value proposition creates customers’ desires to trade their hard-earned dollars for your product.
General Business
Until recently, no formal business model design tools existed. Entrepreneurs had no choice but to use their experience and wits to create business models. Sometimes this unstructured approach worked, and sometimes it didn’t.
The founders of Southwest Airlines may have been successful doodling their business model on the back of a cocktail napkin, but you’ll be better served with a more structured approach.
General Business
Creating a business model can be simple. You simply come up with a great idea to create a product and sell it easily and profitably. Problem solved, right? If you’re lucky enough to create a great product, then yes, you may not need much more of a process. However, most businesspeople need more than just a great idea to become successful.
The most time-tested method of creating cost advantage is to create economies of scale. The great companies from the industrial revolution — railroads, steel, oil, banking, and automotive manufacturing — all utilized economies of scale. After a certain level of production, or scale, was achieved, significant cost savings or additional profits were achieved.
General Business
Companies use employee suggestion boxes for improvements to their business process, but employees can be a valued source of business model improvements as well. Employees have access to the intimate details of customer interactions, business processes, and competition every day. Giving your employees the opportunity and permission to assist with business model innovation is good business.
General Business
To fully leverage a strong competitive advantage, you must shore up the other aspects of your business model as well. As a savvy businessperson, you must go further than competitive advantage analysis and explore all aspects of the business model. By doing so, you can unleash the maximum potential of the business.
There are business models hundreds of years old and those only a handful of years old, such as Internet freemium models. Some of the most profitable companies didn’t invent new business models; they borrowed a business model from another industry.
The Gillette razor and blades model has been highly profitable for Hewlett-Packard’s inkjet printer business and Verizon’s cellphone business.
General Business
The Internet has brought a new mentality to the business world in which users matter more than profit. The concept is to capture a large audience and figure out how to make money from the audience later.
What do Twitter, Groupon, Solar City, biofuel companies, Webvan, and most blogs have in common? They’ve all attracted a vast number of customers but failed to profit from them.
The best way to create a good niche is to find an unserved or underserved market. All blockbuster products do this. To paraphrase Strategyn founder Tony Ulwick, “We don’t buy products for their features and benefits; we buy them to help do specific jobs.”
No one bought a cellphone for what it was; they bought it for what it did — made them safer and more productive while driving.
General Business
To create the best business model possible, find the best place on the industry value chain. Every firm involved in getting a product from initial creation to purchase and consumption by the end consumer adds value in the form of activities, incurs costs, and has a resulting margin. Some positions in this value chain offer a greater opportunity than others.
General Business
Proprietary margin is the ability of your business model to make more money from the same customer than a competitor can make. You can accomplish this by
Getting the customer to pay more for a similar product of similar cost. A cup of Starbucks coffee doesn’t cost more than other coffees; it’s branded and marketed better to command better margin per sale.
General Business
When you're ready to create and analyze your own business model, jot down your ideas while using the business model wheel. This practical tool is also useful when you revisit the ideas you come up with during your annual planning process. The business model wheel focuses on the following areas:
Offering
Market attractiveness: The industry, niche, and customer segment you will sell to.
General Business
Business model innovation is a necessity. The constant march of competition and time causes all business models to erode eventually — you can’t stand still and expect to get ahead. Regularly spend time updating your business model to get the most from your business. If you need innovation inspiration, look at other businesses.
General Business
You’ve likely met a hard-working, well-educated, and talented business owner who never seems to find success. You’ve also probably met a not-so-hard-working, not-so-well-educated, and moderately talented business owner who’s built a stellar business. How do you explain these differences?
It’s simple. The hard-working business owner has a lousy business model and the not-so-hard-working business owner has a great business model.
General Business
Gas stations don’t make money from the sale of gasoline. They make their profit from the sale of higher-margin items like cigarettes and soda. While creating your winning business model, think about which products or services get the customer in the door and which ones keep your business profitable.
The secret to the gasoline, cigarettes, and soda formula lies within buyer psychology.
Any competition drags down margins. Fighting for customers always leads to price/margin cutting. The only way to maintain high margins is to preemptively move to new and better markets before the competition gets intense.
There are three types of competitors: good, bad, and indirect.
Good competitors
Most competitors are good competitors.
The most important step toward creating a great business model is creating a product that customers want and will buy. This is called a powerful offering. The first step in creating a powerful offering is selecting the right market. Picking the combination of industry attractiveness, niche attractiveness, and customer attractiveness creates the best market for your product.
After you pick an attractive industry for your business model, it’s time to find an attractive niche. Your niche market is a subset of the overall market you participate in. Discovery Networks International participates in the broadcast television industry, but its niche is infotainment.
Shows like MythBusters, Dirty Jobs, and Deadliest Catch entertain with an educational bent.
To create the best business model, you should find a profitable and sufficiently large market segment. However, in order to have a successful and durable business model, you need to find a large market that’s unserved or underserved. Finding this underserved market is paramount.
Anyone can find huge markets to attack.
General Business
Generally, companies with better business models have superior margin versus their competition. This table shows the profit per vehicle for several automakers in 2010. Which business model do you think is superior?
Automakers’ Profit per Vehicle
Automaker
Profit Per Vehicle
Vehicles Sold
Profit (Millions)
Profit Per Vehicle Rank
Total Profit Rank
Daimler
$3,316
1,170,000
3,880
1
4
BMW
$3,000
1,224,280
3,673
2
5
Renault
$1,741
1,668,615
2,905
3
6
Nissan
$1,500
3,088,298
4,632
4
3
Ford
$1,320
4,320,792
5,703
5
1
VW
$1,288
4,407,062
5,676
6
1
Honda
$833
3,152,197
2,626
7
7
Hyundai
$810
2,931,325
2,374
8
8
GM
$553
2,202,927
1,218
9
10
Tata
$400
803,322
321
10
12
Toyota
$349
5,496,346
1,918
11
9
Fiat
$292
1,853,282
541
12
11
Mazda
$154
1,307,540
201
13
13
Chrysler
($438)
1,085,211
(475)
14
14
*Not all manufacturers listed.
General Business
All business models erode and grow weaker over time. Your job is to assess the model and make changes before it’s too late. If your profit isn’t what it once was, consider raising your prices — without raising your prices. The following list includes ideas you may want to try:
Revise the discount structure
If you’re looking for the gold standard of margin innovation, look no further than the Minnesota Mining and Manufacturing Company (3M). Growing from a humble sandpaper manufacturer, 3M is now a Fortune 100 global powerhouse with 84,000 employees in 65 countries. 3M’s growth is a result of relentless innovation.
General Business
Venture capitalists do not appreciate hearing about a business model that includes the words, "I'll make it on the back end." When working your business model and thinking about investors, make sure you can see profit right away.
This business plan calls for sacrificing today in the hopes of a better payday later.
General Business
Your customers determine what your unique selling proposition is. Other companies may be fighting for a similar USP with the same customer. Many companies are battling for similar USPs in the toothpaste market. You may be a Colgate user and view that toothpaste’s value proposition as the best one for you. Your next-door neighbor may be a Crest user and feel the value proposition for Crest is better.
After you create a strong USP (unique selling proposition) and UVP (unique value proposition), you can assess the market potential of your product or service. Will you be filling an important unmet need in a multibillion dollar industry or simply babysitting for friends in your neighborhood?
Both of these examples are perfectly valid markets.
When you present your business model to investors, they don't want to hear you say, "My business plan calls for…" This issue is also known as “assuming the hard part.” Every business plan calls for rapid increases in sales, low costs, hiring of outstanding employees — a general euphoric state.
The real world tends to have finicky customers, hard-to-close sales, problem employees, and more.
General Business
If your current business model is no longer effective, it's time to make some changes. When you're designing or re-designing your business model, keep these questions in mind:
Does the model generate margins superior to the competition?
How easily can your idea be copied?
What can you do to slow down the competition?
General Business
Can you clearly and effectively explain your unique value proposition (UVP) in one sentence? It’s not always easy, but it’s absolutely necessary. If it takes a paragraph to explain why people should buy your product, a) they’ll tune you out after ten words and miss the important stuff, and b) your value proposition won’t be finely tuned enough to stand out in a crowded marketplace.
General Business
They’re called innovations for a reason. Great ideas rarely are in the mainstream or are conformist. Some of the best ways to innovate a business model come from unusual or counterintuitive means. Here are ten ways you can buck convention and innovate your business model.
Engage in activities your competitors won’t
It’s easy to have competitive advantage when you have no competitors.
Great business models command better margins than the competition. Sometimes, a business model can be improved simply by clever pricing strategies. The list below offers some methods to potentially raise prices and corresponding margins.
Premium pricing: You can't help but think that expensive products are better.
General Business
Using the crystal ball to help guide your business model is more than just guessing at the future or daydreaming. Using the crystal ball is a process by which you paint a vivid picture of what the business environment will be three to five years from now. Ask yourself:
What will be the general economic climate?
Many businesspeople mistakenly believe that a business plan and a business model are one and the same. Your business model is the core concept upon which you build your business plan. Therefore, your business model should be a significant portion of your business plan.
Many business plans gloss over the business model in favor of lengthy financial projections and operational details that go along with business plans.
General Business
When designing a business model, you have a lot to remember. Refer to this handy list of business-model reminders to make sure you stay on track:
Different is always better than better. The better mousetrap plan rarely works.
No margin, no mission. Great business models have great margins.
If it's not easy to sell, it's not worth doing.
The concept of a business model may be new, but the underlying business dynamics aren’t. The East India Trading Company and Henry Ford had good business models, whether they were called business models or not. For many years, businesspeople have asked themselves two key questions:
Is this a unique concept?
Can I make money selling it?
General Business
Sometimes the best innovation for business is borrowing other people’s innovation. Howard Schultz got the idea for Starbucks while sitting in an Italian café. Plenty of creative product, fashion, and food ideas come from taking a proven product or concept from another area and transplanting it.
Here are some examples:
The Kit Kat bar, which was the idea of an employee, was originally launched in London and the South East in 1935.
General Business
Business model innovation is critical to the long-term success of your enterprise. Still, most people need a starting point for some inspiration — so start with your competition. Sure, competitors are a perpetual burr in your saddle, but if you’re clever, competitors can provide valuable ideas for business model innovation.
General Business
The best ideas for business model innovation can come from companies outside your industry. There’s a reason everyone inside your industry is constrained by the thinking of that industry. They say things like, “Everyone knows you can’t . . .” or “It’s been that way since . . .”
Companies outside your industry aren’t forced to deal with the constraints of your industry.
As you design your business model, focus on your product’s positioning, marketing, and sales process without worrying excessively about competition. You don’t win the race by looking backward. By the same token, completely ignoring the competitive landscape can adversely affect your model. Here are some factors that can drag down your margin:
Attractive market: High potential markets attract competitors.
General Business
A proprietary revenue stream is a revenue source unique to your business model. By creating a proprietary revenue stream, you’ve figured out how to monetize something that your competitors haven’t. As you can imagine, this isn’t easy to do. However, if you can find one, a proprietary revenue stream is usually a big winner.
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