If you’re a budding entrepreneur, you’ll almost certainly run into the term “business model” at some point – if you haven’t already. It’s one of those concepts that seems important yet also rather abstract and hard to define. In reality, a business model should be anything but mysterious: it’s simply the company’s high-level plan for how it will make money. A business model should clearly identify your target customers and the value you offer them, your products and services, how you’ll deliver them, and how you’ll make a profit.
There are many types of business models, including retail product sales, fee-for-service, and subscription-based services. Every company’s operations are based on a business model, even if it’s never formally defined. In fact, a company may have several complementary business models, each with its own target audience, marketing strategy, pricing approach, and expenses. For example, a company that installs air conditioning makes money both by selling systems to new customers and providing service and maintenance to existing customers.
7 Types of Business Models
Business models fall into broad categories, though each company’s model will have some distinct features. The most common types of business models include:
1. Retailer
Retailers buy products from wholesalers and resell them to consumers, either in brick-and-mortar stores or online, or both. To be sustainable, a retail model should offer customers unique value, such as a specialized product selection, a convenient location, or an attractive return policy.
2. Fee-for-Service
A fee-for-service model charges for services by the hour or for a predetermined price. This is an extremely common model among small-business owners, especially those offering services that require specialized skills or training. Examples include doctors, accountants, and plumbers.
3. Manufacturer
A successful manufacturing business model requires a business to profitably produce items that customers want, while managing supply-chain challenges. A sizable investment in raw materials, machinery, and labor is also necessary.
4. Subscription
With a subscription model, customers pay a recurring monthly charge for access to services or products. Almost universal among software companies and video-streaming services, subscription models are also increasingly popular for offerings ranging from online fitness training to cook-at-home meal kits. A key advantage: automatic monthly payments generate a relatively predictable revenue stream that helps a company manage and plan its spending.
5. Franchise
With a franchise business model, a person buys the rights to use an established business model and branding developed by another company, known as the franchisor. The franchisor typically provides products and support in return for a share of revenues or profits. There are thousands of franchisors across sectors, ranging from hardware stores to physical therapy.
6. Advertising or Affiliate Marketing
This business model is common among traditional magazine and TV businesses, bloggers, and social-media influencers. It relies on attracting a large and/or dedicated audience. The business receives a commission when someone clicks on an ad (advertising model) or when they buy a product via a link on a website (affiliate model).
7. Razor and Blades
Named after the famous strategy of selling low-priced razors in order to profit from the subsequent sale of razor blades, this business model attracts customers with a low-cost product that then requires them to buy high-priced supplies on a continuing basis. Another example is inexpensive ink-jet printers and expensive ink refills.
A business model should clearly identify your target customers and the value you offer them, your products and services, how you’ll deliver them, and how you’ll make a profit.
How to Create a Business Model
Whether you’re establishing a new venture or managing an existing business, defining a business model is a valuable exercise that forces you to think about the nuts and bolts of how the company should work. Experts say the business model should concisely describe every important aspect of the business, from its target audience to its primary costs. It may be helpful to structure your thinking by using a simple template; many can be found online.
Here are six areas to consider and questions to ask yourself:
1. Target Audience
Are you selling to urban cat owners? Suburban homeowners who need lawn maintenance? Defining who your key customers are can help you design other aspects of the business, such as your pricing and sales strategies.
2. Value Propositions
What customer problems are you trying to solve, and how do you differentiate your products and services? Think through why customers would choose your company over your competitors.
3. Channels and Customer Relationships
How will you reach new prospects and build customer loyalty? Assess the primary methods you’ll use for initial sales outreach and subsequent communications, such as personal contacts, website sales, email, and social media.
4. Revenue Streams
How will you make money? From product sales? Subscriptions? Advertising? The answer may be a combination of some or all of these and other methods.
5. Activities and Resources
What activities will the business need to perform, and what resources will it need to perform them? For example, will the company sell its products online or in stores? Will it handle delivery of online orders or work with a third-party logistics provider? Think about the resources required for each activity, such as people, office space, software, and production machinery.
6. Expenses
Once you’ve defined the company’s activities and the resources required, you can identify your biggest expenses.
Business Model vs. Business Plan: What’s the Difference?
The terms “business model” and “business plan” are sometimes confused, but they’re distinctly different. A business model is a concise description of how the business will work, while a business plan is a detailed blueprint for how the business will grow over a specific period. A business plan is necessary to attract financing from most lenders and investors. It typically provides a breakdown of the company’s projected sales, expenses, and profits over the next several years, as well as a market analysis and specific financing requirements.
Adapting Your Business Model
A business model shouldn’t be set in stone. When starting a business, it’s unlikely you’ll be able to predict exactly how the business will develop, so you may need to adjust the model to reflect reality. You may also revisit the model to respond to new competition, new opportunities, or changing economic conditions. Critically reexamining your business model can help you think about whether you should change your offerings, adjust pricing, or explore new ways to reach customers. Most companies need to change their business model over time – so why should yours be any different?
