A business model describes the value an organization offers to its customers. It illustrates the capabilities and resources required to create, market and deliver this value, and to generate profitable, sustainable revenue streams.

In principle, a business model does not matter to customers; it is important to the company and the organization of its business. The business model determines the external relationships with suppliers, customers and partners. However, it is primarily focused on the company’s business processes.

Importance of the business model

The business model is the key factor that leads to success in start-ups. It provides the starting point that allows a company to maximize its profits—the sooner the business model is in place, the better. A viable business model is a key determinant (along with product development) in obtaining funding. Also, a business model must be scalable. Investors must be able to envision a start-up’s business model (from an organizational and process perspective) as the company grows.

Defining the business model

A company’s strategy defines the company’s market and customers, and determines the value proposition for the customer’s business. The business model focuses on how a start-up captures some of the value for itself (that is, how the company makes money). It determines the viability of the company. The business model focuses on coordinating internal and external processes to determine how the start-up interacts with solution partners, distribution channels and customers.

Chart illustrating the related parts of a business model, including aspects of infrastructure, finance, customers, and the business' offer. Source: Alex Osterwalder / arvetica

How the business model works

The business model describes, as a system, how the components of the business (that is, organizational strategy, business processes) fit together to produce a profit. It answers the question, “How does this business work?” The answer to the question consists of two parts:

1. It includes a description of the efforts that generate sales, which produce revenue. The value proposition is delivered to the target customer through a distribution channel. The flow and update of the value proposition is influenced by the relationship capital created through the company’s marketing activities.

2. It includes a description of the value-generating parts that make up the cost structure. A company’s value proposition is created through the application of its key functions and abilities, through a configuration of operational activities that includes input and interaction with a partner network.

For more information on the process of designing a business model, see the article entitled Business Model Design.

Creating an innovative business model

Companies that innovate on a business-model level experience greater growth rates than companies that focus on innovation in products and operations. There are several methods that start-ups can use to create an innovative business model:

  • revenue/pricing model: change how revenue is generated through new value propositions and new pricing models (to take advantage of economies of scale)
  • enterprise model: specialize and configure the business to deliver greater value by rethinking what is done in-house and through collaboration
  • industry model: redefine an existing industry, move into a new industry or create a new industry

For more information about developing a business model, download the MaRS workbook, Market Strategy Workbook 3: Strategic Marketing Approach. The information and exercises will help you design a business model by working through the key variables in executing a market strategy—competition, partnership, distribution, pricing and positioning.

References

Kurtzman, J., and Rifkin, G. (2005). Startups That Work. London: Penguin Group.
IBM Global Services. (2006, September). Business model innovation—the new route to competitive advantage. Whitepaper.
IBM Global Services. (2008). The Enterprise of the Future. Whitepaper.