Business model

The term business model describes a broad range of informal and formal models that are used by enterprises to represent various aspects of business, including its purpose, offerings, strategies, infrastructure, organizational structures, trading practices and operational processes and policies. Although the term can be traced to the 1950s, it achieved mainstream usage only in the 1990s. Many informal definitions of the term can be found in popular business literature, such as the following:

A business model is a conceptual tool that contains a big set of elements and their relationships and allows expressing the business logic of a specific firm. It is a description of the value a company offers to one or several segments of customers and of the architecture of the firm and its network of partners for creating, marketing, and delivering this value and relationship capital, to generate profitable and sustainable revenue streams.

— Osterwalder, Pigneur and Tucci (2005)

More recently, researchers build definitions based on economic and organizational theories and show that the definitions are econometrically sound. For example, Malone, et al. (2006) at MIT propose an operational definition of business model, based on theories such as those from transaction cost economics. Zott and Amit (2002) from INSEAD and Wharton based their definition on boundary-spanning transactions.

Simply put: What problem does this business solve and how does it do so profitably?

Components of a business model

Many different conceptualizations of business models exist (Chesbrough and Rosenbloom 2000; Hamell 2000; Linder and Cantrell 2000; Petrovic, Kittl et al.; Weill and Vitale 2001; Gordijn 2002; Afuah and Tucci 2003; Osterwalder 2004; Fetscherin & Knolmayer 2005). They all have various degrees of resemblance or difference. The model proposed by Osterwalder (2004) synthesises the different conceptualizations into a single reference model based on the similarities of a large range of models. The author's conceptualization describes a business model as consisting of nine related business model building blocks. Thus, a business model describes a company's business:

File:Business model components.png

Infrastructure

• core capabilities: The capabilities and competencies necessary to execute a company's business model.
• partner network: The business alliances which complement other aspects of the business model.
• value configuration: The rationale which makes a business mutually beneficial for a business and its customers.

Offering

• value proposition: The products and services a business offers.

Customers

• target customer: The target audience for a business' products and services.
• distribution channel: The means by which a company delivers products and services to customers. This includes the company's marketing and distribution strategy.
• customer relationship: The links a company establishes between itself and its different customer segments. The process of managing customer relationships is referred to as customer relationship management.

Finances

• cost structure: The monetary consequences of the means employed in the business model. A company's DOC.
• revenue: The way a company makes money through a variety of revenue flows. A company's income.

These 9 business model building blocks constitute a business model design template which allows companies to describe their business model.

Evolution

A brief history of the development of business models might run as follows. The oldest and most basic business model is the shop keeper model. This involves setting up a store in a location where potential customers are likely to be and displaying a product or service.

Over the years, business models have become much more sophisticated. The bait and hook business model (also referred to as the "razor and blades business model" or the "tied products business model") was introduced in the early 20th century. This involves offering a basic product at a very low cost, often at a loss (the "bait"), then charging compensatory recurring amounts for refills or associated products or services (the "hook"). Examples include: razor (bait) and blades (hook); cell phones (bait) and air time (hook); computer printers (bait) and ink cartridge refills (hook); and cameras (bait) and prints (hook). An interesting variant of this model is a software developer that gives away its word processor reader for free but charges several hundred dollars for its word processor writer.

In the 1950s, new business models came from McDonald's Restaurants and Toyota. In the 1960s, the innovators were Wal-Mart and Hypermarkets. The 1970s saw new business models from FedEx and Toys R Us; the 1980s from Blockbuster, Home Depot, Intel, and Dell Computer; the 1990s from Southwest Airlines, Netflix, eBay, Amazon.com, and Starbucks. Poorly thought out business models were a problem with many dot-coms.

Today, the type of business models might depend on how technology is used. For example, entrepreneurs on the internet have also created entirely new models that depend entirely on existing or emergent technology. Using technology, businesses can reach a large number of customers with minimal costs.

Example business models over the years

• The subscription business model
• The razor and blades business model (bait and hook)
• The pyramid scheme business model
• The multi-level marketing business model
• The network effects business model
• The monopolistic business model
• The cutting out the middleman model
• The auction business model
• The online auction business model
• The bricks and clicks business model
• The loyalty business models
• The Collective business models
• The industrialization of services business model
• The servitization of products business model
• The low-cost carrier business model
• The online content business model
• The freemium business model
• The premium business model
• The direct sales model
• The professional open-source model
• Various distribution business models

Do Business Models Matter?

Malone et al. (2006) at MIT find that some business models, as defined by them, indeed performed better than others in a dataset consisting of the largest U.S. firms, in the period 1998 through 2002, while they did not prove whether or not the existence of a business model mattered or not.

Zott and Amit (2002) also link business models to varying degrees of performance, in the context of 190 young, growth-oriented firms in the US and Europe that had gone public between 1996 and 2000. See also their additional research on value drivers.

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Related Concepts

The process of business model design is part of business strategy. The implementation of a company's business model into organizational structures (e.g. organigrams, workflows, human resources) and systems (e.g. information technology architecture, production lines) is part of a company's business operations. It is important to understand that business modeling commonly refers to business process design at the operational level, whereas business models and business model design refer to defining the business logic of a company at the strategic level.

See also

• Business model design
• Business process modeling
• Business plan
• Growth Platforms
• Market forms
• Marketing
• Marketing plan
• Monopoly
• Strategic management
• Strategic planning
• Value migration
• Business rule