4/26/20

Lecture - 5
Business Models

Entrepreneurship and Innovation

KUSOM, MBA, 2020
Faculty - Shashi Raj Bajracharya

Business Models
§ Understanding Business Model
• Business Models
• Business Model Design
• Components of Effective Business Model
• Types of Business Models
§ Changing the Model
• Changing Business Model
• Potential Flaws of Business Models
§ Business Model Innovation
• Business Model Canvas
• Value Proposition

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5.1.1 Business Models

• 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.

• A Business Model is a conceptual structure that supports the viability of a

product or company and explains how the company operates, makes money,
and how it intends to achieve its goals. All the business processes and
policies that a company adopts and follows are part of the business model.

• According to Peter Drucker: - a business model is supposed to answer who

your customer is, what value you can create/add for the customer and how
you can do that at reasonable costs. Thus a business model is a description
of the rationale of how a company creates, delivers and captures value for
itself as well as the customer.

5.1.1 Business Models

• A business model is an "abstract representation of a business, be it
conceptual, textual, and/or graphical, of all core interrelated
architectural, co-operational, and financial arrangements designed and
developed by an organization presently and in the future, as well as all
core products and/or services the organization offers, or will offer, based
on these arrangements that are needed to achieve its strategic goals and
objectives."Al-Debei, El-Haddadeh and Avison (2008)
• This indicates that value proposition, value architecture (the
organizational infrastructure and technological architecture that allows
the movement of products, services, and information), value finance
(modeling information related to total cost of ownership, pricing
methods, and revenue structure), and value network articulate the
primary constructs or dimensions of business models.

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5.1.1 Business Models

A business model describes the rationale of how an organization creates,
delivers, and captures value, in economic, social, cultural or other
contexts. The process of business model construction is part of business
strategy.

Every business model intrinsically has three parts:

i. Everything related to designing and
manufacturing the product
ii. Everything related to selling the product, from
finding the right customers to distributing the
product
iii. Everything related to how the customer will pay
and how the company will make money
***

5.1.2 Business Model Design

Business model design generally refers to the activity of designing a
company's business model. It is part of the business development and business
strategy process and involves design methods. It includes the modeling and
description of a company’s:

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5.1.2 Business Model Design

• Economic consideration
Al-Debei and Avison (2010) consider value finance as one of the main dimensions of
BM which depicts information related to costing, pricing methods, and revenue
structure. Stewart and Zhao (2000) defined the business model as a statement of how
a firm will make money and sustain its profit stream over time.
• Component consideration
Osterwalder et al. (2005) consider the Business Model as the blueprint of how a
company does business. Slywotzky (1996) regards the business model as the totality
of how a company selects its customers, defines and differentiates it offerings, defines
the tasks it will perform itself and those it will outsource, configures its resources, goes
to market, creates utility for customers and captures profits.
• Strategic outcome
Mayo and Brown (1999) considered the business model as the design of key
interdependent systems that create and sustain a competitive business. Casadesus-
Masanell and Ricart (2011) explain a business model as a set of choices (policy, assets
and governance) and consequences (flexible and rigid) and underline the importance
of considering how it interacts with models of other players in the industry instead of
thinking of it in isolation. ***

5.1.3 Components of Effective Business Model

• Core strategy (how a firm competes)

• Strategic resources (how a firm acquires and uses its resources)
• Partnership network (how a firm structures and nurtures its
partnerships)
• Customer interface (how a firm interfaces with its customers)
Entrepreneurship, Successfully Launching New Ventures – Bruce R. Barringer, R. Duane Ireland (Third or
Fourth Edition, Pearson)

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5.1.3 Components of Effective Business Model

1. Core Strategy
The first component of a business model is the core strategy, which describes how
a firm competes relative to its competitors. It is observed that things can go wrong
quickly for a company that doesn’t have a focused core strategy.

• Mission Statement
A firm’s mission, or mission statement, describes why it exists and what its
business model is supposed to accomplish.

• Product/Market Scope
A company’s product/market scope defines the products and markets on which it
will concentrate. The choice of product has an important impact on a firm’s
business model. New ventures should be particularly careful not to expand their
product/ market offerings beyond their capabilities.

5.1.3 Components of Effective Business Model

2. Strategic Resources
A firm is not able to implement a strategy without adequate resources. This reality
means that a firm’s resources substantially affect how its business model is used.
For a new venture, its strategic resources may initially be limited to the
competencies of its founders, the opportunity they have identified, and the unique
way they plan to service their market.

• Core competencies
It is a resource or capability that serves as a source of a firm’s competitive advantage over
its rivals. It is a unique skill or capability that transcends products or markets, makes a
significant contribution to the customer’s perceived benefit, and is difficult to imitate. A firm’s
core competencies determine where a firm is able to create the most value. (i) unique, (ii)
valuable to customers, (iii) difficult to imitate, and (iv) transferable to new opportunities.

• Strategic assets
They are anything rare and valuable that a firm owns. E.g, plant and equipment, location,
brands, patents, customer data, a highly qualified staff, and distinctive partnerships.

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5.1.3 Components of Effective Business Model

3. Partnership Network
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. In
most cases, a business does not want to do everything itself because the majority of
tasks needed to build a product or deliver a service are not core to a company’s
competitive advantage.

• Suppliers
all firms have suppliers who play vital roles in the functioning of their business models. A
supplier (or vendor) is a company that provides parts or services to another company.
Companies are focusing on supply chain management, which is the coordination of the
flow of all information, money, and material that moves through a product’s supply chain.

• Other Key Relationships

Firms also partner with other companies to make their business models work. E.g,
strategic alliances, joint ventures, networks, consortia, and trade associations etc

5.1.3 Components of Effective Business Model

4. Customer Interface

Customer interface means how a firm interacts with its customers and it depends on how the
firm chooses to compete. Sometimes a company’s customer interface will change as conditions
change.

• Target Market
The target market a firm selects affects everything it does, from the strategic resources it
acquires to the partnerships it forges to its promotional campaigns.

• Fulfillment and Support

It is 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

• Pricing Structure
Pricing structures vary, depending on a firm’s target market and its pricing philosophy.
***

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5.1.4 Types of Business Model

• Manufacturer
A manufacturer makes finished products from raw materials. It may sell directly
to the customers or sell it to a middleman i.e another business that sells it finally
to the customer. E.g., – Ford, 3M, General Electric.

• Distributor
A distributor buys products from manufacturers and resells them to the retailers
or the public. E.g., – Auto Dealerships.

• Retailer
A retailer sells directly to the public after purchasing the products from a
distributor or wholesaler. E.g., – Amazon, Tesco.

5.1.4 Types of Business Model

• Franchise
A franchise can be a manufacturer, distributor or retailer. Instead of creating a
new product, the franchisee uses the parent business’s model and brand while
paying royalties to it. E.g., – McDonald’s, Pizza Hut.
• Brick-and-mortar
Brick-and-mortar is a traditional business model where the retailers,
wholesalers, and manufacturers deal with the customers face-to-face in an
office, a shop, or a store that the business owns or rents.
• eCommerce
E-Commerce business model is an upgradation of the traditional brick-and-
mortar business model. It focuses on selling products by creating a web-store
on the internet.

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5.1.4 Types of Business Model

• Bricks-and-clicks
A company that has both an online and offline presence allows customers to
pick up products from the physical stores while they can place the order online.
This model gives flexibility to the business since it is present online for
customers who live in areas where they do not have brick-and-mortar stores.
E.g., – Almost all apparel companies nowadays.

• Nickel-and-dime
In this model, the basic product provided to the customers is very cost-sensitive
and hence priced as low as possible. For every other service that comes with it,
a certain amount is charged. E.g., All low-cost air carriers.

5.1.4 Types of Business Model

Freemium
This is one of the most common business models on the Internet. Companies
offer basic services to the customers for free while charging a certain premium
for extra add-ons. So there will be multiple plans with various benefits for
different customers. Generally, the basic service comes with certain restrictions
or limitations, such as in-app advertisements, storage restrictions etc., which
the premium plans shall not have. This model is one of the most adopted
models for online companies because it is not only a great marketing tool but
also a cost-effective way to scale up and attract new users.

• Subscription
If customer acquisition costs are high, this business model might be the most
suitable option. The subscription business model lets you keep customers over
a long-term contract and get recurring revenues from them through repeat
purchases. E.g., – Netflix, Dollar Shave Club.

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5.1.4 Types of Business Model

• Aggregator
Aggregator business model is a recently developed model where the company various
service providers of a niche and sell their services under its own brand. The money is
earned as commissions. E.g., – Uber, Airbnb, Oyo.
• Online Marketplace
Online marketplaces aggregate different sellers into one platform who then compete
with each other to provide the same product/service at competitive prices. The
marketplace builds its brand over different factors like trust, free and/or on-time home
delivery, quality sellers, etc. and earns commission on every sale carried on its
platform. E.g., – Amazon, Alibaba.
• Advertisement
Advertisement business models are evolving even more with the rise of the demand for
free products and services on the internet. Just like the earlier times, these business
models are popular with media publishers like Youtube, Forbes, etc. where the
information is provided for free but are accompanied with advertisements which are
paid for by identified sponsors.

5.1.4 Types of Business Model

• Data Licensing / Data Selling
With the advent of the internet, there has been an increase in the amount of
data generated upon the users’ activities over the internet. This has led to the
advent of a new business model – the data licencing business model. Many
companies like Twitter and Onesignal sell or licence the data of its users or
users of users to third parties which then use the same for analysis, advertising,
and other purposes.

• Agency-Based
An agency can be considered as a partner company which specialises in
handling the non-core business activities like advertising, digital marketing, PR,
ORM, etc. This company partners with several other companies that outsource
their non-core tasks to them and is responsible to maintain privacy and
efficiency in their work. E.g., Ogilvy & Mathers, Dentsu Aegis Network, etc.

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5.1.4 Types of Business Model

• Affiliate Marketing
Affiliate marketing business model is a commission-based model where the
affiliate builds its business around promoting a partner’s product and directs all
its efforts to convince its followers and users to buy the same. In return, the
affiliate gets a commission for every sale referred. E.g., lifewire.com.

• Dropshipping
Dropshipping is a type of e-commerce business model where the business
owns no product or inventory but just a store. The actual product is sold by
partner sellers who receive the order as soon as the store receives an order
from the ultimate customer. These partner sellers then deliver the products
directly to the customer. E.g., Shopify

5.1.4 Types of Business Model

• Network Marketing
Network marketing or multi-level marketing involves a pyramid structured network of
people who sell a company’s products. The model runs on a commission basis where
the participants are remunerated when – (i) They make a sale of the company’s
product and (ii). Their recruits make a sale of the product.
This model works on direct marketing and direct selling philosophy where there are no
retail shops but the offerings are marketed to the target market directly by the
participants. The market is tapped by making more and more people part of the
pyramid structure where they make money by selling more goods and getting more
people on board.

• Crowdsourcing
Crowdsourcing business model involves the users to contribute to the value provided.
This business model is often combined with other business and revenue models to
create an ultimate solution for the user and to earn money. Examples of businesses
using the crowdsourcing business model are Wikipedia, reCAPTCHA, Duolingo, etc.

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5.1.4 Types of Business Model

• Peer 2 Peer Catalyst/Platform
A P2P economy is a decentralized internet-based economy where two parties
interact directly with each other to buy or sell goods or to conduct a transaction
without the intervention of any third party. A P2P catalyst is a platform where
these users meet. E.g., Craigslist, OLX, Airbnb etc.

• Blockchain
The Blockchain is an immutable, decentralized, digital ledger. It is a digital
database that no one owns but anyone can contribute to. Many businesses are
taking this decentralised route to develop their business models. Models based
on blockchain are not owned or monitored by a single entity. Rather, they work
on peer-to-peer interactions and record everything on a digital decentralized
ledger.

5.1.4 Types of Business Model

• SAAS, IAAS, PAAS
Many companies have started offering their software, platform, and infrastructure as a
service. The ‘as a service’ business model works on the principle of pay as you go
where the customer pays for his usage of such software, platform, and infrastructure;
he pays for what and how many features he has used and not for what he hasn’t.

• High Touch
The High Touch model is one which requires lots of human interaction. The relationship
between the salesperson and the customer has a huge impact on the overall revenues
of the company. The companies with this business model operate on trust and
credibility. E.g., – Hair salons, consulting firms.

• Low Touch
The opposite of the High Touch model, the Low Touch model requires minimal human
assistance or intervention in selling a product or service. Since as a company, you do
not have to maintain a huge sales force, your costs decrease, though such companies
also focus on improving technology to further reduce human intervention while making
the customer experience better at the same time. E.g., – Ikea, SurveyMonkey

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5.1.4 Types of Business Model

• Pay what you can (PWYC)
A non-profit or for-profit business model which does not depend on set prices
for its goods, but instead asks customers to pay what they feel the product or
service is worth to them. It is often used as a promotional tactic.
"Pay what you want" (PWYW) is sometimes used synonymously to "pay what
you can" which is often more oriented to charity or socially oriented uses, based
more on ability to pay, while "pay what you want" is often more broadly oriented
to perceived value in combination with willingness and ability to pay.

To conclude, most companies do not operate on any one of these business

models but rather on a combination of some. Like it is perfectly possible for you
to be a Bricks-and-clicks Low Touch Retailer or a High Touch Subscription-
Based Manufacturer. What business model you choose depends on your
business needs and what value you want to create for your stakeholders.
***

5.2 Changing Business Model

There is no standard business model, no hard-and-fast rules that dictate how a
firm in a particular industry should compete. New ventures should not assume
that the venture can be successful by simply copying the business model of
another firm - even if that other firm is the industry leader.
• It is difficult to precisely understand all of the components of another firm’s
business model.
• A firm’s business model is inherently dependent on the collection of resources
it controls and the capabilities it possesses.

To achieve long-term success though, all business models need to be modified

across time. The reason for this is that competitors can eventually learn how to
duplicate the benefits a particular firm is able to create through its business
model.

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5.2.1 Potential Flaws of Business Models

Business models that fall victim to flaws have lost the race before leaving the
starting gate.

Misread of the customer

a product must have customers to be successful, the companies must have
sufficient number of customers and must be able to read the customer
requirements correctly. E.g., pets.com

Unsound economics
When the margins are too small and the scale of business does not justify the
costs involved in its transaction.

***

5.3 Business Model Innovation

Business Model Innovation refers to a business model that revolutionizes how a

product is produced, sold, or supported after the sale.

Since there is no standard business model that guarantees success when used
in a particular industry or a specific segment of an industry. Firms approach
their markets in different ways and devise different ways to make money.

Firms are continually introducing business model innovations to find ways to

add value in unique ways and revolutionize how products and services are sold
in their industries.

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5.3.1 Business Model Innovation

Business Model Canvas
Business Model Canvas is a strategic
management and lean startup template for developing
new or documenting existing business models. It is a
visual chart with elements describing a firm's or
product's value proposition, infrastructure, customers,
and finances. It assists firms in aligning their activities
by illustrating potential trade-offs.

Business Model Canvas were initially proposed in

2005 by Alexander Osterwalder based on his earlier
work on business model ontology. Since the release of
Osterwalder's work around 2008, new canvases for
specific niches have appeared.
https://www.youtube.com/watch?v=QoAOzMTLP5s
https://www.youtube.com/watch?v=434HUjsxfYw

5.3.1 Business Model Innovation

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5.3.1 Business Model Innovation

Value Proposition Canvas
The Value Proposition Canvas is about finding out why the customer needs a supplier,
what the customer can perceive as an extra value and what the customer finds
annoying or disadvantageous.

A value proposition describes the benefits customers can expect from a bundle of
products and services. So you best know the customer first.

Value Proposition is an important component of the the Business Model Canvas (BMC)
and focuses on an important part of BMC, namely the value proposition that the
product or service has for the customer.

https://www.youtube.com/watch?v=RpFiL-1TVLw
https://www.youtube.com/watch?v=D254suPMpwY

5.3.1 Business Model Innovation

Value Proposition Canvas

https://www.youtube.com/watch?v=RpFiL-1TVLw
https://www.youtube.com/watch?v=D254suPMpwY
*****

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