If you are a small business, you rarely think of your business as having a business model. But it does. It does because the moment you have a single paying customer, she is paying for the value you create. It is another matter, if your business makes a profit consistently over the long term. Sustainable profit is why it is important to understand the business model concept.Here is a definition based on the highly cited article by David Teece.
A business model is the manner in which you provide value to your customer that is paid for (by whom – is considered in the questions below). You cover your costs and make a profit on a sustainable basis.
ADAPTed from David Teece (2010).
If you are wondering what is my business model, answering the following 7 questions will help:
- What customer problem are you trying to solve? The customer tries to solve a problem when she uses any product or service. Key to this idea is that there are different segments of customers who think of problems differently. For example, car buying is highly stressful for some segments of customers while some others seem to enjoy the process. A famous marketing example is that customers don’t buy drill bits, they need to drill holes! So if you are a drill bit manufacturer you need to take the time to understand all about what kind of surfaces (wood, baseboard,metal) that the customer might be working on.This understanding will go into the kind of material used in the drill bit and its design.
- Who will pay you? Traditionally the user was the customer who paid you, the supplier. With the Internet things have changed radically in many industries. We search Google for free and Google sees the searching people as their primary customers. The money comes from businesses who pay Google for AdWords to put out their message right when someone is searching. In Airbnb and Uber a small percentage is taken from the transaction cost as revenue. A popular joke about Silicon valley business models is about the bar that has a million people coming in who do not buy anything and leave. Yet the bar’s valuation is sky high as the business hopes to gain advertising revenue from bar visitors!
- How large is the target market/addressable market or market segment? Target markets and total addressable markets are also called segments, that have certain characteristics. These are:
- Measurable: You should be able to numerically estimate the number of potential buyers.
- Substantial: The market must be of a minimum size so that it can support all your costs including a profit margin.
- Be accessible: You must be able to access that market both for delivery and advertising. If the authorities do not allow a store to be set up or do not allow you to advertise- you can’t access the market.
- Be distinct: The people you are trying to target must have common but unique needs that are not being fully met by existing offerings.
- Be somewhat stable: Markets change all the time, but at least at the time of planning you should expect that things will remain stable for your business to establish.
- Initially narrowly defined target markets allow great marketing focus. For example, if you are trying to market an online music tutoring service for school children, market geographically to one town, parent ages between 25-55, interested in sport and music you can get a pretty good idea of who these people are. And then you have easy ways of reaching them through advertising on billboards at the town, through flyers in the mailbox, through Google and Facebook geo targeted ads, the local newspaper etc. Initially such kind of focussed narrow target market definition is important to get all pieces of the business streamlined. This includes the product, pricing, delivery and advertising. However, the total addressable market/market segment must be defined at the outset keeping the above characteristics in mind.
- What is the customer doing now? Who are the competitors? The customer is doing something. If you supply lawn mowing services – homeowners in your target market must have lawns and apartment homes are naturally excluded. The target market homeowners might be a) mowing their own lawns or b) having competitors doing the work. Each of these markets will need a different value offering and marketing approach.
- What will it cost to deliver? If you are a new business it pays to be conservative in estimating costs. Assume that it’ll cost more than you imagine. If you are already in business carefully accounting for your own time will surprise you. You don’t get paid even minimum wage– many business owners tell us. Remember (Sales – Costs)= Profits and is a great way to think about costs. You find that reducing costs (via technology, outsourcing) or increasing a) sales price or b) adding customers are the only ways to get the profit equation to work.
- What is your marketing message? What you say to customers at least initially has to be carefully crafted to encourage a response. Your marketing message needs to be just right. If you think about it, in developed markets deodorants are rarely marketed with the message that you stink. In contrast, in emerging markets that is the message that works as the market is in the early stages.
- How easy is it for you to stop imitators from snatching market share? No matter what your business model or market share if your business model can be easily copied – you do not have a sustainable business. Constantly refining “what’s special” about your offering is the key here. Imitators can be disrupters that are new business models based on technology. The neighborhood travel agent has disappeared to online travel sites like Expedia and the average tax preparer has tough disruptive competition from TurboTax. Today change is so rapid that patent protection is not enough and is not common in many industries.
Business models are never static and need constant refining to keep up with changes. Asking these seven questions on a regular basis and working on better answers can help your business stay ahead.