Chapter 4 – Business Models

A startup is a temporary organization in search of a scalable, repeatable, profitable business model. – Blank and Dorf (2012, p. xvii)

Today countless innovative business models are emerging. Entirely new industries are forming as old ones crumble. Upstarts are challenging the old guard, some of whom are struggling feverishly to reinvent themselves.

How do you image your organization’s business model might look two, five, or ten years from now? Will you be among the dominant players? Will you face competitors brandishing formidable new business models? – Osterwalder, Pigneur, and  Clark (2010, p. 4)

Overview

In this chapter, the concept of the business model is introduced. One concept of the business model in particular, the Business Model Canvas, is explored as a way to conceptualize and categorize elements of a business model.

What are Business Models?

Magretta (2002) described business models as “stories that explain how enterprises work” (p. 87) and Osterwalder, et al. (2010) said that they describe “the rationale of how an organization creates, delivers, and captures value” (p. 14). Chatterjee (2013) said that “A business is about selling what you make for a profit. A business model is a configuration (activity systems) of what the business does (activities) and what it invests in (resources) based on the logic that drives the profits for a specific business” (p. 97).

The Business Model Canvas

The Business Model Canvas tool is based on the premise that a start-up is something quite different than an ongoing venture. A start-up should not be viewed as a smaller version of a company because starting-up a company requires very different skills than operating one does. A start-up that is still a start-up after some time—maybe after a couple of years for some kinds of start-ups—is actually a failed enterprise since it hasn’t converted into an ongoing venture (Osterwalder et al., 2010).

The business model canvas is made up of nine parts that, together, end up describing the business model.

Figure 3 – Business Model Canvas from http://www.businessmodelgeneration.com (Designed by: Strategyzer AG, strategyzer.com, Creative Commons Attribution-Share Alike 3.0 Unported License)

The following elements of the Business Model Canvas were taken, with permission, from http://www.businessmodelgeneration.com.

• Key partners
  • Who are our key partners?
  • Who are our key suppliers?
  • Which key resources are we acquiring from partners?
  • Which key activities do partners perform?
  • Motivations for partnerships: optimization and economy; reduction of risk and uncertainty; acquisition of particular resources and activities
• Key activities
  • What key activities do our value propositions require?
  • Our distribution channels?
  • Customer relationships?
  • Revenue streams?
  • Categories: production; problem-solving; platform/network
• Key resources
  • What key resources do our value propositions require?
  • Our distribution channels?
  • Customer relationships?
  • Revenue streams?
  • Types of resources: physical; intellectual (brand patents, copyrights, data); human; financial
• Value propositions
  • What value do we deliver to the customer?
  • Which one of our customer’s problems are we helping to solve?
  • What bundles of products and services are we offering to each customer segment?
  • Which customer needs are we satisfying?
  • Characteristics: newness; performance; customization; “getting the job done”; design; brand/status; price; cost reduction; risk reduction; accessibility; convenience/usability
• Customer relationships
  • What type of relationship does each of our customer segments expect us to establish and maintain with them?
  • Which ones have we established?
  • How are they integrated with the rest of our business model?
  • How costly are they?
  • Examples: personal assistance; dedicated personal assistance; self-service; automated services; communities; co-creation
• Customer segments
  • For whom are we creating value?
  • Who are our most important customers?
  • Mass market; niche market; segmented; diversified; multi-sided platform.
• Channels
  • Through which channels do our customer segments want to be reached?
  • How are we reaching them now?
  • How are our channels integrated?
  • Which ones work best?
  • Which ones are most cost-efficient?
  • How are we integrating them with customer routines?
  • Channel phases:
    • Awareness – How do we raise awareness about our company’s products and services?
    • Evaluation – How do we help customers evaluate our organization’s value proposition?
    • Purchase – How do we allow customers to purchase specific products and services?
    • Delivery – How do we deliver a value proposition to customers?
    • After sales – How do we provide post-purchase customer support?
• Revenue streams
  • For what value are our customers really willing to pay?
  • For what do they currently pay?
  • How are they currently paying?
  • How would they prefer to pay?
  • How much does each revenue stream contribute to overall revenues?
  • Types: asset sale; usage fee; subscription fees; lending/renting/leasing; licensing; brokerage fees; advertising
  • Fixed pricing: list price; product feature dependent; customer segment dependent; volume dependent
  • Dynamic pricing: negotiation (bargaining); yield management; real-time-market
• Cost structure
  • What are the most important costs inherent in our business model?
  • Which key resources are most expensive?
  • Which key activities are most expensive?
  • Is your business more: cost driven (leanest cost structure, low price value proposition, maximum automation, extensive outsourcing); value driven (focused on value creation, premium value proposition).
  • Sample characteristics: fixed costs (salaries, rents, utilities); variable costs; economies of scale; economies of scope

The idea is to keep adding descriptions or plans to the nine components to create the initial business model and then to actually do the start-up activities and replace the initial assumptions in each of the nine parts with newer and better information or plans to let the business model evolve. This model is partly based on the idea that the owner should be the one interacting with potential customers so he or she fully understands what these potential customers want. These interactions should not only be done by hired sales people, at least until the business model has evolved into one that works, which can only happen when the venture owner is completely engaged with the potential customers and the other business operations (Osterwalder et al., 2010).

A business plan shouldn’t be created until the above has been done because you need to know what your business model is before you can really create a business plan (Osterwalder et al., 2010). This seems to imply that the Business Model Canvas is best suited to technology-based and other types of companies that can be basically started and operated in some way that can later be converted into an ongoing venture. By starting operations and making adjustments as you go, you are actually doing a form of market research that can be compiled into a full business plan when one is needed.

According to Osterwalder, et al. (2010), the things we typically teach people in business school are geared to helping people survive in larger, ongoing businesses. What is taught—including organizational structures, reporting lines, managing sales teams, advertising, and similar topics—is not designed to help students understand how a start-up works and how to deal with the volatile nature of new ventures. The Business Model Canvas idea is meant to help us understand start-ups.

The Business Model Canvas tool is intended to be applied when business operations can be started on a small scale and adjustments can continually be made until the evolving business model ends up working in real life. This is in contrast to the more traditional approach of pre-planning everything and then going through the set-up and start-up processes and ending up with a business venture that opens for business one day without having proven at all that the business model it is founded upon will even work. These traditional start-ups sometimes flounder along as the owners find that their plans are not quite working out and they try to make adjustments on the fly. It can be difficult to make adjustments at this time because the processes are already set up. For example, sales teams might be in the field trying to make sales and blaming the product developers for the difficulty they are having, and the product developers might be blaming the sales teams for not being able to sell the product properly. The real issue might be that the company simply isn’t meeting customers’ needs and they don’t have any good mechanism for detecting and understanding and fixing this problem.

Lean Start-up

Consistent with the Business Model Canvas approach, Ries (2011) advanced the idea of the lean start-up. His definition of a startup is “a human institution designed to create a new product or service under conditions of extreme uncertainty” (p. 27), and the lean start-up approach involves releasing a minimal viable product to customers with the expectation that this early prototype will change and evolve frequently and quickly in response to customer feedback. This is meant to be a relatively easy and inexpensive way to develop a product or service by relying on customer feedback to guide the pivots in new directions that will ultimately—and relatively quickly—lead to a product or service that will have the appeal required for business success. It is only then that the actual business can truly emerge.

Ries’s (2011) five lean start-up principles start with the idea that entrepreneurs are everywhere and that anyone working in an environment where they seek to create new products or services “under conditions of extreme uncertainty” (27) can use the lean start-up approach. Second, a start-up is more than the product or service; it is an institution that must be managed in a new way that promotes growth through innovation. Third, startups are about learning “how to build a sustainable business” (p. 8-9) by validating product or service design through frequent prototyping that allows entrepreneurs to test the concepts. Forth, startups must follow this process or feedback loop: create products and services; measure how the market reacts to them; and learn from that reaction to determine whether to pivot or to persevere with an outcome the market accepts. Finally, Ries (2011) suggested that entrepreneurial outcomes and innovation initiatives need to be measured through innovative accounting.

Figure 4 – Business Model and Lean Start-up Books (Photo by Lee A. Swanson)

Growth Wheel

According to its website, GrowthWheel® (http://www.growthwheel.com/) is a decision-making tool for start-up and growth companies to help business advisers and entrepreneurs focus, set agendas, make decisions, and take action (GrowthWheel, 2015). It is effectively a more complex and detailed tool than the Business Model Canvas for describing a business model. A web search will yield a variety of tools, like the Business Model Canvas and the GrowthWheel®, that can be used to describe business models.

Franchises as Business Models

Franchises are basically business models developed by others (franchisors) that have been proven to work in multiple contexts and that are sold to entrepreneurs (franchisees) who will implement the business model in contexts that the franchisor believes will result in a successful enterprise. Franchises apply various business models. Some are turnkey franchises, like McDonald’s, where the entire business structure is set up from the design of the stores to the supply system, and the franchisor sets up virtually everything for the new franchisee. Other franchise models, like that defining Tap ‘N’ Pay Canada (http://www.tapnpay.ca/)—a business that provides debit and credit card machines and point of sale equipment—advertise relatively low fees charged to franchisees and quick set-ups in as little as two weeks (http://www.betheboss.ca/franchises/tap-n-pay).