Business Model

CHAPTER NOTES

I.          Business Models

            * Material following the opening feature on Amie Street.

            1.  A business model is a firm’s plan or diagram for how it competes, uses its

                 resources, structures its relationships, interfaces with customers, and creates

                 value to sustain itself on the basis of the profits it earns.

            2.  It’s important to understand that a firm’s business model takes it beyond its

                 own boundaries.  Almost all firms partner with others to make their business

                 models work.

            3.  There is no standard business model, no hard-and-fast rules that dictate how

                 firms in a particular industry should compete. 

            4.  The term business model innovation refers to initiatives such as that

                 undertaken by Michael Dell that revolutionized how products are sold in an

                 industry. 

            5.  The development of a firm’s business model follows the feasibility analysis

                 stage of launching a new venture but comes before the completion of a

                 business plan. 

                 a.  If a firm has conducted a feasibility analysis and knows that it has a product

                      or service with potential, the business model stage addresses how to

                      surround it with a core strategy, a partnership model, a customer interface,

                      distinctive resources, and a approach to creating value that represents a

                      viable business model.

                 b.  At the business model development stage, it is premature for a new venture

                      to raise money, hire a lot of employees, establish partnerships, or

                      implement a marketing plan.  A firm needs to have a business model in

                      place before it can make additional substantive decisions.

A.    The Importance and Diversity of Business Models

1.      Importance of Business Models

a.        Having a clearly articulate business model is important because it

does the following:

-          Serves as an ongoing extension of feasibility analysis.

-          Focuses attention on how all the elements of a business fit together and constitute a working whole.

-          Describes why the network of participants needed to make a business idea viable would be willing to work together.

-          Articulates a company’s core logic to all stakeholders, including the firm’s employees

                           

b.       Once a firm’s business model is clearly determined, the entrepreneur

 should diagram it on paper (to the extent possible), examine it, and

 ask the following questions:

-          Does my business model make sense?

-          Will the businesses I need as partners participate?

-          If I can get partners to participate, how motivated will they be? Am I asking them work for or against their self-interest?

-          How about my customers? Will it be worth their time to do business with my company?

-          If I do get customers, how motivated will they be?

-          Can I motivate my partners and customers at a sufficient scale to cover the overhead of my business and make a profit?

-          How distinct will my business be? If I’m successful, will it be easy for a large competitor to step in and steal my idea?

-           

2.      Diversity of Business Models

a.       There is no standard business model for an industry or for a target

market within an industry.  For example, there are five distinct ways

that online companies make money.  These approaches, shown in

Table 6.1, are the core piece of their respective company’s business

models.

b.      There are always opportunities for business model innovation.  Think of Netflix in movie rentals, Wikipedia in encyclopedias, and Curves

International in fitness clubs. 

II.        How Business Models Emerge

1.      The value chain is a model developed by an academic researcher that many businesspeople as well as entrepreneurs use to identify opportunities to enhance their competitive strategies.

2.      The value chain is the string of activities that move a product from the raw material stage, through manufacturing and distribution, and ultimately to the end user.

3.      By studying a product or service’s value chain, and organization can identify ways to create additional value and assess whether it has the means to do so.

4.      Value chain analysis is also helpful in identifying opportunities for new businesses and in understanding how business models emerge.

5.      A firm can be formed to strengthen the value chain for a product, however, only if a viable business model can be created to support it.

III.       Potential Fatal Flows of Business Models

1.      Two fatal flaws can render a business model untenable from the beginning.

a.       A complete misread of customers.

b.      Utterly unsound economics.

IV.       Components of an Effective Business Model

            A.  Core Strategy

                  1.  The first component of a business model is the core strategy, which

                       describes how a firm competes relative to its competitors.  The following

                       are the essential components of a firm’s core strategy.

                       a.  Mission Statement.  A firm’s mission, or mission statement, describes

                            why it exists and what its business model is supposed to accomplish

                       b.  Product/Market Scope.  A company’s product/market scope defines

                            the products and markets on which it will concentrate. 

                       c.  Basis for Differentiation.  It is important that a new venture differentiate

                            itself from its competitors in some way that is important to its

                            customers.  If a new firm’s products or services aren’t different from

                            those of its competitors, why should anyone try them?

                            i.   From a broad perspective, firms typically choose one of two generic

                                 strategies (cost leadership or differentiation) to position themselves

                                 in the marketplace.

                            ii.  Firms that have a cost leadership strategy strive to have the lowest

                                 costs in the industry, relative to competitors’ costs, and typically

                                 attract customers on that basis.

                            iii. In contrast, firms with a differentiation strategy compete on the basis

                                 of providing unique or different products and typically compete on

                                 the basis of quality, service, timeliness, or some other important

                                 dimension. 

            B.  Strategic Resources

                 1.  A firm is not able to implement a strategy without resources, so the

                      resources a firm has affects its business model substantially.  The two

                      most important strategic resources are discussed below.

                      a.  Core Competency.  As defined in Chapter 3, a core competency is

                           a resource or capability that serves as a source of a firm’s competitive

                           advantage over its rivals.  Examples of core competencies include

                           Sony’s competence in miniaturization, Dell’s competence in supply

                           chain management, and 3M’s competence in managing innovation.

                       b.  Strategic Assets.  Strategic assets are anything rare and valuable that

                            a firm owns.  They include plant and equipment, location, brands,

                            patents, customer data, a highly qualified staff, and distinctive

                            partnerships.

                 2.  Companies ultimately try to combine their core competencies and

                      strategic assets to create a sustainable competitive advantage.  This

                      factor is one to which investors pay close attention when evaluating

                      a business.

            C.  Partnership Network

                 1.  A firm’s network of partnerships is the third component of a business

                      model.  New ventures, in particular, typically do not have the resources

                      to perform all the tasks required to make their businesses work, so they

                      rely on partners to perform key roles.

a.       Suppliers.  A supplier (or a vendor) is a company that provides parts

or services to another company.  Almost all firms have suppliers who

play a vital roles in the functioning of their business models.

                      b.  Other Key Relationships. Along with its suppliers, firms partner with

                           other companies to make their business models work.

                           i.  There are risks involved in partnerships, particularly if a single

                               partnership is a key component of a firm’s business model. 

                           ii. Many partnerships fall short of meeting the expectations of the

                               participants for a variety of reasons.  

           

C.     Customer Interface

1.  Customer interface – how a firm interacts with its customers – is the fourth

     component of a business model.  The type of customer interaction depends

     on how a firm chooses to compete.

     a.  Target Market.  A firm’s target market is the limited group of

          individuals or businesses that it goes after or tries to appeal to.

          i.  The target market a firm selects affects everything it does, from

              the strategic assets it acquires to the partnerships it forges to its

              promotional campaigns.

b.      Fulfillment and Support.  Fulfillment and support describes the way

a firm’s product or service “goes to market” or how it reaches its

customers.  It also refers to the channels a company uses and what level

of customer support it provides.

c.       Pricing Structure.  A third element of a company customer interface is

its pricing structure.  Pricing models vary, depending on a firm’s target

market and its pricing philosophy.