All business operations can be reduced to three words: people, product and profits. And your business model is how you profit from what it is you’re selling (your product) to the people you’re selling it to (your customers). Here’s everything you need to know to create a business model.
In a hurry? Skip ahead to your favourite part:
What is a business model?
What is a business model canvas?
The 9 parts of a business model
The 10 most common business models
How to create a business model
How to analyse a business model
How to make a profit
How much can you sell your product or service for?
How much profit will you make?
What is the difference between bottom up and top down business model?
Profit vs Passion
Your business model is arguably one of the most important aspects of your business, because it’s not only how you make money, but it’s how you stay in business. Without profit, you have no business. And profit in business comes from repeat customers. Customers that boast about your product or service, and that bring their friends with them. As well as your ability to operate the business efficiently.
So what is a business model? Your business model is how your business will capture revenue and spin a profit. Even if you’re a start up chasing venture capital and you’re reinvesting into the business so aggressively that you technically aren’t ‘profitable’ now, your business will need to have a cash flow positive (profitable) business model at some point – after all; investors want a return on their money.
You know when you’re telling someone about a crazy new business idea, they turn to you and say – “hmmm, I’m not sure about that one. Sounds risky. I can’t see it working. No one will ever buy that….” And all of a sudden the wind has been knocked out of your sails and you start to question everything? Well, being able to build a profitable business model around your idea is the perfect way to validate even the most far-fetched of ideas and get buy-in from partners, stakeholders and investors alike. And the sooner you can piece it all together, the better.
What is a business model?
Your business model is your business’s plan for how it will generate profit. Because if you can generate profit, your idea can stand on its own two feet. Usually this is by selling something of value to customers who will pay you for your product or service. You’ll know you’ve got a successful business model when you’re able to deliver real value while keeping your costs low, you get overwhelming positive reviews and your product or service sells itself. Or even better, your customers refer you to new customers.
What is a business model canvas?
One of the best ways to map out your business model is to build a business model canvas…
A business model canvas summarises what would normally be in your 100 page business plan into a simple 1 page snapshot of how it’ll all come together.
What are the 9 parts of a business model canvas?
Customer segments – who your customers are and the pain point your business solves. And while it sounds obvious, your solution needs to be valuable enough that they’ll want to pay good money for it, and your customers need to have the money to pay for it.
Value proposition – this is the product or service of value that you’re selling, or your solution to your customer’s pain point.
Channels – the various touch points or avenues you will sell your product or service to your customers. For instance, online, in-store and over the phone.
Customer relationships – is the relationship you’ll have with your customer while you deliver your value proposition.
Key activities – are the operations you’ll use to create and deliver your value proposition. These are generally the essential operations that must take place in order to generate revenue.
Key resources – a list of the key people and assets that are essential for the operations to work reliably and sustainably.
Key partnerships – is a list of who outside of your organisation is required to do business. For instance, suppliers, distributors, outsourced marketing agencies or hosting services.
Cost structure – a summary of what it costs to reliably deliver your value proposition to your customers.
Revenue streams – how your value proposition(s) is priced and the different forms you may sell it in order to capture that value from your customers.
What are examples of business models?
The 30 most common business models:
Advertising – You’re an attention merchant. This is an evolution of the print business model, which is simply where readers pay a dollar for all the content within and that supports the enterprise. Nowadays most commonly you’re a media publisher or content platform and you derive revenue by providing free access to content which attracts your audience, and you make money by charging advertisers to market their business to your audience. Sometimes you might also offer an ‘ad-free’ subscription model as an alternative. In this business model you’ll monitor your daily active users (DAU), monthly active users (MAU) and usage metrics like user logged-in percentage, average session duration and pages per session.
Subscription / Leasing – You sell your product or service to your customer on a recurring, automated basis. Like Netflix. And you’ll track your monthly recurring revenue (MRR), compound monthly growth rate (CMGR), user churn, CAC and the lifetime value (LTV) of the average customer.
SAAS – Software As A Service works much like a subscription model, but what you’re specifically selling here is software which is usually in the cloud and so the business model has many nuances unique to software. And your measure of success will be your monthly and annual recurring revenue (MRR and ARR), churn, CAC and LTV of the average customer.
Marketplace – You provide a platform for people to buy and sell. Sellers bring their goods or services and list them for sale on your platform. And buyers browse your listings to find the item they want to purchase. Like ebay or Amazon. And you track Gross Merchant Sales, net revenue, net revenue CMGR, user retention and CAC.
E-commerce – You list and sell your physical products online, and you usually ship the product to the customer. Your KPIs will be gross monthly revenue, CMGR, gross profit margin and CAC.
Usage-based – Similar to a subscription model, only this time, your customers pay you per number of units of your product or service they use within that billing cycle. It scales with your needs so you only pay for what you use. Such as your mobile phone plan, car rentals that charge per mile, or API providers that charge per query.
Enterprise – You sell services or software to enterprise businesses on a single license, usually contractual basis, with terms and deliverables that are usually specific to the customer’s needs. Usually your KPIs will be based around bookings, customers and top line revenue.
Hardware – You sell hardware (physical) products to your customers, like Apple, Fitbit or Nike. And like ecommerce you’ll monitor your gross monthly revenue, CMGR, gross profit margin and CAC.
Donations – You run a charity or organisation primarily focused on helping others, but it still needs to operate like a business in order to be sustainable, efficient and productive. Your primary source of revenue is from donations, particularly repeat donors, so you track gross monthly donations, average donation per donor, cost to acquire a new donor and the lifetime value of each donor.
Auction-based – Your buyers have the opportunity to bid on what it is you’re selling, with the highest big winning. The auctions may be automated live real-time like Google Ads keyword bidding, or run over a period of days like bidding on an item on Ebay.
Reverse Auction – Your buyers typically post a job request, and your sellers for the job. Most often this results in the lowest bidding winning, however, sometimes experience and expertise may also play a part in the selection process.
Razor-blade – You sell lost-leader products often with minimal profit margin, like a computer printer or a new car, but you may larger profits on upselling and cross selling after sales services and parts.
Pay-what-you-want / Donation-based – Buyers donate an amount of their choosing to support your operation, but payment isn’t required for customers to access your product or service. Often they are given a suggested price range, and they can opt to pay what they want.
Nickel-and-dime – Your revenue model starts by selling a customer a free or cheap product that requires paid add on or upgrades, which is what you make the bulk of your profit from.
Discounter – You heavily discount your products and position yourself as the cheapest on the market, or best value, and you derive revenue by selling high volumes, rather than high profit margins
Aggregator – You bundle products or services and sell them under one banner instead of singular.
Distributor – You buy and import products in bulk from manufacturers, your business is large scale warehousing and logistics, and sell wholesale to retailers, who then sell to the end consumer.
Data broker – You’re a merchant of data of various types, including personal data, purchasing, property etc, and you sell in one-off transactions as well as licensed access, or via an API.
Affiliate / Referral-based – A spin off of the advertising model, you typically operating a brand or channel that attracts an audience, and refers that audience to retailers that sell a product, and you earn a % of the sales from those retailers.
Consulting – You have acquired expertise in a field and you sell your knowledge and skills as a service to your customers, usually charged out at an hourly basis.
Agency model – Similar to consulting, only your team of talent usually executes on the advise, which means your revenue is derived from a combination or being paid by the hour, or based on deliverables, or a project basis.
Franchising – You’ve build a brand of significant value and you sell the rights for others to operate under your brand in exchange for paying you royalties. Such as McDonalds
(API) Licensing – You own a specific database or digital asset that can be accessed via an API, and you license the use of that access, usually charging a fee per query, or per bulk queries of the API.
Drop-shipping – Drop-shipping is most often an ecommerce business model, only you sell products you don’t nessesarily warehouse. You market the product, process the transaction, and only then do you place the order from your supplier, who invoices you, while the supplier ships directly to the end customer. This model has much lower start up costs than traditional ecommerce.
Value-added reseller – You purchase multiple products, combine and create bundles to increase their overall value, before selling it to the end user.
Revenue sharing – You partner with other businesses to facilitate a sale and split the profits in proportion to the agreement or contribution.
Barter – You exchange goods of value rather than money. Like an influencer takes free product in exchange for the influence promoting the product. Keep in mind, you still pay taxes on the value of the goods.
Trash to cash – You purchase waste or undervalued goods relatively cheaply, overhaul or refurbish then before selling them for a profit.
Results based – You charge based on your performance. For example, as a % of gross sales, and often, the % may be on a sliding scale that varies as revenue scales.
Crowd funding – You’re primarily financed by fans who are also your first consumers.
How do you create a business model?
It’s often said when building a business that you shouldn’t be a driven businessman, but instead a driven artist. Don’t focus on the money, focus on creating something truly beautiful, remarkable, and valuable – remembering that beauty is in the eye of the beholder. Because it’s only when something is truly remarkable will your customers bring you new customers – and as we know – this is how we generate profits.
Creating a business model can be a little overwhelming at first, especially if your idea is new, but doesn’t have to be difficult. But it is a heck of a lot easier if you map out your business model using a business model canvas.
And just before you get started, consider these top tips:
Focus less on your idea and what you want, and build your business (your solution to your customer’s problems) around what your customers want.
Write down what reputation you want your business to have, and script the ideal conversation between an existing customer and a new customer… What will your customers boast about?
Build talk triggers into your business operations so you give your customers reasons to talk about you.
Always put your customer first. It’s not necessarily always the case that your customer is always right, but they are the reason you’re in business.
How to make a business model for a startup
Not since the steam engine has any invention disrupted business models like the Internet. Whole industries including music distribution yellow-pages directories landline telephones and fax machines have been radically reordered by the digital revolution.
Creating a business model for a startup is no different to any other business in principle, but it should be expected that you’ll run a lean operation in the early days while the business is in its infancy, and evolve as you reinvest your initial profits.
Where possible, it also pays dividends to integrate purpose into your for-profit business model through a long term commitment to a cause that is aligned with your core values and those of your community. If you can create a scenario where customers feel good about spending money with you, you’re certainly on the right track.
How to analyse a business model
One way analysts and investors evaluate the success of a business model is by looking at the company’s gross profit.
Gross profit is a company’s total revenue minus the cost of goods sold (COGS). Comparing a company’s gross profit to that of its main competitor or its industry sheds light on the efficiency and effectiveness of its business model.
Gross profit alone can be misleading, however. Analysts also want to see cash flow or net income. That is gross profit minus operating expenses and is an indication of just how much real profit the business is generating.
How to make a profit
It’s not easy, that’s for sure. And anyone who makes it look easy has put in years of hard work behind the scenes that no one sees. Just like maintaining a healthy body in your personal life, profitable businesses take a lot of hard work and consistency. Just like your diet, your business must be lean. And just like you invest in your own self development in the gym – you need to be constantly working on your business to help strengthen its weak spot, and further improve your strengths.
Being profitable is about being efficient and effective with the two most valuable resources you have – your time and your money. It’s called asset allocation – and how you allocate your assets is one of the single biggest factors that impacts your profitability and rate of growth.
Understanding that profit is the difference between revenue and expense will go a long way to streamlining your business model and operations. And as you know, profit in business comes from repeat customers. Customers that boast about your product or service and that bring friends with them. So integrating purpose into your business model through a long term commitment to a cause that is aligned with your core values and those of your community will go a long way to ensuring your business is profitable over the long term. As will investing in what your customers truly care about – not necessarily what you do.
Ask yourself:
What are the costs of delivering your product or service? These are usually broken down into 3 buckets – your cost of goods sold (COGS), such as the cost price of a product you sell. Your cost of acquiring a customer (CAC), which are typically your sales and marketing costs. And your everyday operating expenses (overheads), such as the office rent, computers, phones etc.
How much can you sell your product or service for?
Ever heard the saying, “it’s a buyer’s market?” In a free marketplace like most businesses operating in today, supply and demand for your product or service is what determines your selling price. If the demand is low, you may have to lower your price to move stock. If the demand is high, you may be able to increase your prices slightly. The buyers (demand) and your availability and stock levels (supply) or your competitors (alternative supply) have a bigger impact on how you price your product or service than you do. Unless your unique value proposition is truly unique.
How much profit will you make?
Profit is the difference between what you can sell your product or service for, and your cost of delivering the product. So if you sell a product for $100. Minus $50 COGS. Subtract another $20 CAC. And $10 to cover overheads. Your profit before taxes is $20. And while it doesn’t sound like much, a 20% profit margin is quite healthy. Some highly competitive businesses – such as restaurants and food delivery – may only make 5% profit, or less. And it’s what you do with your profits today that determines how profitable you’ll be tomorrow.
What is your revenue potential?
This is where you’re trying to find out if your idea is worth pursuing… and you can get a gauge on this by assessing the Total Addressable Market (TAM) – the total number of potential customers in this market. The Serviceable Available Market (SAM) – the segment within the market that are able to be sold to now. And the Serviceable Obtainable Market (SOM) – the portion of available customers you’re capable of acquiring vs your competitors.
So to work out your revenue potential:
Customers x Frequency x Price x Potential = SOM revenue
Multiply the number of customers in the target market (TAM) x how often they purchase your product x the price of your product x the % of the total market you’re able to actually sell to = how much gross revenue you could make.
If you then subtract COGS (50%), CAC (20%) and overheads (10%) from your gross revenue potential = you’ll get your potential net revenue.
Even if you have found a business model that is economical, if you don’t have a big enough market to sustain the business and future growth, even the most innovative of ideas won’t make it very far. It’s one of the many reasons why 20% of businesses fail in their first year, and 75% of businesses last less than 15 years.
What is a top down business model?
And what is the difference between bottom up and top down approach?
A top down business model means the goals, focus, tasks and budgets of the team are decided and prioritised by upper management and handed down to lower management and employees to execute. Whereas a bottom up model empowers employees to set goals, tasks and budgets which are presented to upper management to sign off.
Profit vs Passion
The whole game here is to do what you love, and love what you do. Money will come and go in business. You can make 5-8% on your money without lifting a finger just by putting your money into a mutual fund or ETF. So your business needs to make more than that to justify all the ups and downs. Do your homework, do it for the love, and for your people, and if you find a way to add value to the world, the profit will come.
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