Business Model Fundamentals: What do you need to know?

When searching the internet for what a business model is, you have probably come across the following sentence by Alex Osterwalder: "A business model describes the logic of how an organisation creates, delivers and captures value". 

If you keep looking, you will find that most people agree on the following: at its core, it is a tool that helps you describe how your business makes money. Although this is a very superficial definition, it will do for the moment, but if you want to understand what Osterwalder is referring to and learn a bit more about Business Models I invite you to continue reading this blog about the basics to find out what it really is, what types of business models exist, how they can be useful to you and what their benefits are. 

Article with similar content: What is a Business Model? Business Models Explained 

Index 

• What is it? 
• What are the types of business models? 

• What is it for? 
• What are its advantages and disadvantages? 

What is it? 

First, let's talk about how it is made up so that you can understand it better. A business model, as explained by Yves Pigneur and Alex Osterwalder in their book "Business Model Generation" is made up of nine blocks. 

1. Customer Segments (CS): these are the groups of people or organizations that your business plans to reach. 
2. Value Proposition (VP): this is the product or service you offer that generates value for your customer segment; after all, this is the reason why they are looking for you. 
3. Channels (CH): these are the communication channels through which your business reaches the customer segment and through which it delivers the value proposition. 
4. Customer Relationships (CR): is the type of relationship you have with your customers (personal assistance, the contact is automated, the customer serves himself as when he searches for something on Google, among others). 
5. Revenue Streams (RS): is the way in which your business makes money from your customer segment (from sales of products or services, from subscriptions, from loans, from licenses to use intellectual property, from ad placements, among others). 
6. Key Resources (KR): the physical, financial, intellectual, or human resources that your business needs to generate and deliver the value proposition, reach the customer segment, and make money. 
7. Key Activities (KA): the most important activities that your business needs to perform to generate and deliver the value proposition, reach the customer segment, and make money. 
8. Key Partnerships (KP): these are the strategic alliances that can be created with suppliers, non-competing companies, or even direct competitors. These alliances can improve raw material procurement processes, seek economies of scale, or even reduce risks and uncertainty. 
9. Cost Structure (CS): all those costs that your business has to cover in order to operate normally. 
   

Osterwalder is the creator of the Business Model Canvas, a canvas that allows you to better visualize your business model and which I recommend you use because it will also help you to define it. Also, I remind you that you can have several business models in your company, each value proposition needs its own business model, but you will understand this better in the next section. 

Related article: Alex Osterwalder’s Business Model Canvas template: why use it and how 

What are the types of business models? 

Now that you have a better idea of what it is, let's talk about some types of business models. You read that right, a company may have more than one way of making money and you need to go through the exercise for each value proposition to find out. Yves and Osterwalder talk about "patterns", which are common behaviors of some business models that will help you understand how they work and how you can develop yours. 

Pattern #1: Disaggregation of business models 

This is where three types of business activities can co-exist in the same company. One of the examples used by the authors of the book is private banking. 

• Focus on client communication: such as a personalized wealth management service. 
• Innovation through products: such as financial products and services. 
• Infrastructure provision: such as the management of transactions through an infrastructure. 

You are basically separating various value propositions into three different types of business model, customer care, products or services and infrastructure. 

Pattern #2: Long Tail Business Models 

You may have heard the term High Mix Low Volume in some logistics books. It is a strategy that arises from the need to give your customers the opportunity for personalisation, something that is becoming important nowadays as everyone wants to differentiate themselves. This strategy consists of giving a wide variety of options but selling few units of them. 

I think the example in the book makes it clearer. Lego used to be a company that sold packs of pieces to make pirate ships or spaceships, usually looking to movie blockbusters to generate them and looking to sell lots of units of these packs. But a few years ago, it updated its business model and developed Lego Factory, where any customer could make their own design and Lego would make it available for sale. This means that it increases the number of designs available so that everyone has more buying options, but few units of each pack are sold.  

Pattern # 3: Multi-sided platform business models 

Think of Google, eBay, Amazon, or Microsoft. These are platforms that generate value by facilitating interaction between different customer segments, so their value increases the more users participate. Google connects customers seeking information with information providers, generating money through advertisements; Visa allows linking merchants with banks; Apple is perhaps one of the best examples, with the iPhone it allows application, music and book developers to connect with their customers through the App Store, this is the multi-sided platform. 

Pattern #4: Free as a business model 

Here one segment of the market has access for free to certain content that is kept available because another part of the market is paying for something extra. The best example I can give you is Spotify; you can enjoy music for free and the platform is maintained by other people paying to enjoy the extras the membership offers. Another example is all those free mobile games, if you want to play them without ads, they will offer you to pay, as well as if you want some extra that helps you to level up quickly. 

Here there is also another business model called the Bait and Hook, where you get something practically for free (or very cheap), but a product or service needed to use it is sold to you separately. For example, companies that practically give away mobile phones in exchange for high monthly service fees. Or mechanical razors with replaceable heads, you buy the razor, but eventually you will need spare parts. 

Pattern #5: Open business models 

This business model needs the collaboration of external partners. Either from outside the company inwards, as when I design a process or service and someone else automates it; or from the inside out, as when I develop intellectual property and monetize it through patents. 

All this was extracted from the book and summarized, but I recommend you read it to learn more and to be able to take better advantage of the knowledge you are acquiring. 

What is it for? 

Now that you have an idea of what your business model is and what type it is, we could start by talking about the importance of documenting it. In other blogs I have mentioned that you can only improve what you measure, but you can only measure what you know, and the best way to know your business is to document it. Having a clear written idea of your business model helps you understand what the most important parts are you should pay attention to. 

Again, I recommend using a Business Model Canvas to document and facilitate visualization. Once you have done this, you have several options to make the most of it. Here are five uses Strategyzer recommends that you could explore. 

Strategic planning or development 

A Business Model Canvas will give you a basis to guide you in organizing your strategies and developing your business. Strategyzer mentions that he has seen companies use this tool to plan in a simple way, because they can observe, in a general way, what the different units of the companies are doing. In addition, the dissemination of projects can be smooth as the Canvas becomes an easy-to-understand strategic planning program. 

In retrospect of your business 

This tool allows you to see what you have done in the past. If you update your business model, by simply saving the information you can look at how you did things before and compare the results over time, so you can see which changes have been positive and which have been negative and generate a better perspective to plan what you are going to do in the future. 

To create or maintain portfolios of business models 

Having a portfolio of business models will let you see which ones are making money and which ones aren't. Which ones are making money today and which ones can make money tomorrow? Which ones are generating today, and which ones can generate tomorrow? Beyond growth, a portfolio can help you understand the potential synergies between business models. The example Strategyzer gives is a technology that Nestlé used for one product (value proposition), then developed and used in different products (value propositions) in coffee, tea, and baby formula businesses. 

As a cross-functional language 

We have also talked in other blogs about the importance of having horizontal communication between departments in companies. A vertical hierarchical communication prevents the development of the company's full potential because each department only knows the customer in one of its facets. A Business Model Canvas integrates marketing, technology, engineering, operations, finance, and other areas. In this way, everyone will know the business better, will be able to contribute their knowledge and understand each other, which will allow better strategic plans to be generated and better decisions to be made. 

To make investment decisions 

Visualizing your business model allows you to identify your company's strengths and weaknesses. In other words, it allows you to find opportunities for improvement where to focus your efforts and resources. This prioritization will help you to keep old business models alive and to leverage new ones to bring your portfolio to fruition. 

I recommend you read the whole article to learn about more uses you could put your business model to:  14 Ways to Apply the Business Model Canvas 

What are its advantages and disadvantages? 

You have probably already deduced them by reading about the uses of the Business Model Canvas, however, here I show you some extra benefits. Of course, nothing is perfect, so I also bring you some points against it that you should consider when using it. 

Advantages 

• Helps you focus your strategies on problem solving. 

• Determines the core function of your company, its parts, and the way they relate to each other. 
• Facilitates understanding of your business logic for everyone in your business. 
• Allows openness to discussion between different departments, which generates powerful insights to develop more robust strategies. 
• It is easy to understand and use. 
• It reduces the risk of failure. 

Disadvantages 

• It is not a methodology or a strategy. It is a tool that you must learn to use. 
• It completely omits the study of the competition in the market. You can canvas your competition to understand it, but this is extra work that you will have to do separately. 
• It does not present current issues such as sustainability, social responsibility, and environmental factors. Issues that are gaining popularity because of the impact they have. 

• It does not consider stakeholders beyond customers. 
• It is not always filled with data-driven information, but with assumptions. 

It is important that you understand the components of a business model, although your company can survive without a Business Model Canvas, I recommend that you try to put some effort into it. Having your canvas well organized will allow you to identify opportunities and plan your strategies to gain a competitive advantage. Moreover, you might discover that it is not your product that generates money, but the way you deliver it to your market segment, or you might find the secret to lower costs by strengthening your strategic alliances, maybe you didn't even know that your business model could change to a more profitable one. That is why you should not delay starting using this tool.