Long ago in the dot-com era, business models were the rage. But along with other questionable notions like cost-per-eyeball and stickiness, the concept of business models has fallen into disuse. It’s now time to revive this powerful shortcut to profitable thinking.
What is a business model and why would you need one?
A business model succinctly describes how your business will make money. It is shorthand, a model–insuring that all your business bases are covered, detailing only the essential elements: how you produce a product or service people need and want, how you put that product in their hands, and how you make a profit.
That seems simple enough, doesn’t it? But have you actually gone through this exercise?
Have you taken the time to consider the critical factors for your business success, making sure you have adequately addressed each one?
Suppose your business is already generating a profit. Do you need a business model?
Consider this: If you can’t describe–briefly and to the point–how your business performs each critical function, you are probably not earning the most money possible from the opportunities available to you.
But a business model is more than just a list of the essential elements–it is a cohesive narrative which you can communicate easily–to customers, vendors, lenders, investors, employees, anyone…
And just like a financial model–which allows you to identify and tweak various components like lead conversion rates or the cost of money–a business model helps you identify, then tweak, individual components to increase your profit.
There are four key parts to a solid business model:
The Value Proposition
Your value proposition links the individuals and organizations in your market segment to the products and services you offer, via the unique constellation of ‘value elements.’ Your value proposition answers the questions: who are they buyers, what will they buy, and why will they buy it.
The Production System
Some people call these operations. We like ‘production system’; it states clearly that this is about producing value. Your production system is the way you deliver your company’s unique value to your customers, in the form of products, services or both. It could involve creating something in-house or outsourcing. It could involve manufacturing from raw materials, assembling components, or even buying finished goods for resale. It could involve providing services with your own staff, using outside contractors, or assembling a team of virtual contributors.
The Distribution System
Your distribution system includes those parts of your business which identify potential buyers and helps them buy your product or service. This is what people traditionally think of as marketing and sales. It also includes logistics decisions like format, packaging, and delivery mechanisms.
The Profit Formula
This is how your company is going to make money. As it is said, do the math! You cannot buy high and sell low expecting to make it up on volume, regardless of what people hoped in the dot-com era.
Buy low and sell high will make you money, but unfortunately that little bit of info that doesn’t tell you quite enough to get rich. You must buy low, make whatever you buy worth more via some kind of added value, and then sell high enough, over and over again. Your profit formula describes how you are going to do that.
Of course, there are numerous other secondary components to running a business, but your business model will only include them when they are pivotal to your particular business design. For instance, a company which provides on-call engineers would include its special method for recruiting qualified engineers, which in most companies would be considered part of the HR function.
If each element works well on its own, the value proposition is sufficiently unique and compelling, you can economically and reliably produce value for your market, you have a repeatable and cost effective way of identifying and selling to customers, and finally you can sell things for more money than they cost. You will make money. But if any part of the model does not work, in the long run, and the long run could come quite quickly, you will go broke.
Your first step to profiting from a business model is to describe your own. List each of the four headings on its own fresh sheet of paper. Then write, in narrative form, how each works in your business. This may take one paragraph, it may take a page. If it takes any more it is likely too complicated.
Make sure you can describe each clearly and simply, value proposition, production system, distribution system, and profit formula. If an area is not sufficiently clear to you, it needs work, immediately. Because this area is holding back your business and costing you money.
Avi E. Ram