As you start up your business you may find people asking you “What is your business model?”. A business model is the approach you will choose to follow to achieve your business goals.
An even simpler way of thinking about it is that a business model is a description of how you will make money.
Working out your business model is an important step for any business. As your business is not fully up and running, much of the information you use to work out your business model will be based on assumptions i.e. you don’t really know at this stage, there is a bit of guesswork involved. But a business model will provide a framework for you to test your assumptions, benchmark against other available information and get feedback from other business owners, potential customers or experts.
In its simplest form, a business model can be broken into three parts:
What it takes to make something: design, raw materials, manufacturing, staff, etc.
What it takes to sell that thing: marketing, distribution, delivering a product/service, processing the sale
What and how the customer pays: pricing, payment methods, payment timing, etc.
If you are making more money from your customers than it costs you to make your products/services, you have a successful business model.
Your business model should also include details of the market your business will operate in, in particular the total size of that market and the proportion you believe your business can capture. For example, the market size might be £100m and you think you can capture 1% of that market within five years, meaning that you would have a turnover of £1m in year five.
Once the market figure and projected income is established (and remember, this is simply a forecast based on information you know right now), your business model will then show how your business plans to capture the identified portion of the market (e.g. how you will get to £1m turnover in your fifth year of trading).
Do this by working out your projected costs and how you will sell your product/service e.g. online or via shops. Explain what sets your business apart from competitors or where you have identified a market gap. All of this will help justify the price you charge customers. Then add in all your projected costs and finally work out the amount of profit you will make. That’s your business model.
Gather in as much information as you can to help develop your business model, for example statistics on the market, competitor approaches and customer research. Your own experience and expertise may be valuable but above all ensure that you test your assumptions with others such as potential customers, industry experts and investors. It’s often easy to assume that you know what customers want…and quite often you can be completely wrong! Test, test and test again. That’s really what business modelling is all about – testing.
A small pilot can be a really useful way to show the demand for your business idea and to test your approach and assumptions before deciding on a final business model and launching your business.
Business models can be generic or they can align to specific areas such as sales, service, franchising, manufacturing or e-commerce. Some other terms you might hear are subscription model, freemium model, marketplace model, franchise model, pay-as-you go model, razor and blade model. For example, Netflix is a subscription model, eBay is a marketplace model and McDonalds is a franchise model. Look around at products and services that you already use and see if you can work out what business model they use. This may help you to understand business models more and work out what model is right for your business.
If you have not worked with business models before, the range of models to choose from can seem a bit daunting. But remember that business models can change and be refined as your business grows and changes. So start by picking the model that you think helps you to set out your target market and the process by which you will make money now. Once you have the initial details of your business model set out, it is easier to refine, adapt and adjust later, ensuring that your business gets off to the best start.