Business Models

Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Are Business Models?

Business Models are plans and strategies that define the functioning and operations of a business based on costs and pricing. These assist customers, investors, employees, and other stakeholders understand how a business makes profits or earns revenue through its operations.

Business Models

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A business model is a company’s fundamental identity while engaging with customers and other stakeholders. It works like a charter on which a business thrives and provides its goods and services to the end consumers. Examples of business models include retailers, manufacturers, e-commerce platforms, brokers, franchises, etc. 

Key Takeaways

  • Business models refer to a business’s strategies and procedures for conducting its operation by simultaneously evaluating costs and prices. 
  • An enterprise that aims to achieve higher revenues and profits works according to different business models that help it achieve these objectives. 
  • These models can differ from business to business, depending on their products, target audience, revenue goals, location, key partners, etc. 
  • An effective business model assists a business idea by increasing revenues and profits for a company in the long run. 

Business Models Explained

Business models meaning describes the line of work to its customers, investors, employees, and other stakeholders. It helps them understand why, how, and what it produces, sells, and earns revenue. This intrinsic information works like a value proposition that helps stakeholders set their demands and expectations from a business. It gives them reasons to engage with a particular business or company amongst other competitors.

For example, a car manufacturing company may not sell its components directly to the customer or unauthorized dealers. Rather, a car manufacturer will add value and use these parts and components to build their company’s car model. They might also establish their authorized service centers on a pay-for-service model. 

From time to time, enterprises modify and evolve into innovative business models to remain relevant and respond to changing customer demands and business environments. In addition, macro-economic factors like inflation, economic growth, fiscal policy, interest rates, and employment cycles influence a business model.

For instance, an interest rate increase may increase a start-up enterprise’s borrowing costs. This rate hike will push it to develop a more economical business framework to increase cash flow and profits. However, an increase in the total cost of production will ultimately lead to higher prices for the customers, which reduces the competitiveness of a business. 

Businesses always aim to earn higher gross profits (total revenue – the cost of goods sold) either by increasing the prices or reducing the cost of inventory and production.

However, to get a true picture of a business model’s profitability, one may look at the net income or cash flow situation by subtracting operational costs from gross profits. Thus, the net income or cash flow variable proves a model’s success and guides the enterprise to remain sustainable and run in the long run.

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Types

Let us look at the types of business models that aid an enterprise in earning its revenue goals, achieving profitability, and becoming competitive and sustainable. 

  1. Manufacturing – The manufacturing sphere is one of the oldest business models wherein an enterprise produces finished goods from scratch using raw materials or assembling unfinished goods and providing them to consumers through B2B or B2C distribution framework.
  2. Retail – A retail business model is responsible for procuring goods and services from manufacturers or distributors and works as the last link in a supply chain by servicing customers directly. It is also known as B2C.
  3. Franchise – This enterprise is born when a business sells its idea or product for reproduction and operations in different markets and locations. An example of this could be IKEA or McDonald’s.
  4. Fee-for-service – A business may charge hourly, monthly, or on a project basis for providing expert services by professionals. For example, law and consultancy firms. 
  5. Subscription – When a business provides its goods and services only through subscriptions such as dairy products or streaming platforms.
  6. Affiliate or Advertising – It is a business model wherein an influencer may collaborate with a brand or company to help them market and sell their products. For example, vloggers on YouTube may share codes for discounts for certain app services.
  7. Freemium  – A freemium business provides some of its goods and services for free or at minimal prices. It profits by selling premium or deluxe versions of its products to customers. Grammarly, Zoom, and Canva are some examples.
  8. Distribution – A business that procures and purchases goods and services in bulk from a manufacturer to resell these products to retailers. It is also known as the B2B (business-to-business) framework. For example, the consumer electronics supply chain.  

Examples

Let us look at some innovative business models in the 21st century:

Example #1

Circular business models refer to innovative enterprises that aim to shrink their operational ecological footprint and reduce social costs. In short, practicing this model involves eliminating the excessive waste of resources, recycling and recovering resources utilized in the production process, or using expensive resources more efficiently.  

For instance, Adidas launched its first eco-friendly shoes in the 2021 summer with the slogan “made to be remade.” It gave a clear message about recycling, reusing, and circular business models as a way forward for the companyThus, Adidas’s sustainable product FutureCraft.Loop promises high performance for runners and the promise to recreate new shoes from broken down or discarded pieces.  

Example #2

Another significant and world-renowned example among different business models is the razor blade model, popularised by King C. Gillette, the founder of razor company Gillette. It derives its name after Gillette company’s successful business strategy to sell the razor tool to its customers at a cost and generate revenue through selling its premium design blades.

Thus, the razor and blade business model thrived by selling a primary or core product at a low price or for free while profiting from the complimentary premium product sales. In Gillette’s case, the premium product was the 3-4 times more expensive blades set. As a result, it not only achieved a cost and revenue equilibrium but also expanded into mass consumer markets internationally. 

Components Of Business Model

Different business models may require different components to thrive and achieve the breakeven point or higher revenues. However, any model will include these few basic components, such as:

  1. Purpose of the business.
  2. The target audience of a business.
  3. Value propositions for customers and other stakeholders.
  4. Research and development to achieve sustainable growth in the long run and improve product or service quality. 
  5. Developing expertise or unique selling point (USP).
  6. Identifying key business partners from sourcing raw materials to selling points, as no business can thrive in isolation.
  7. Closing loopholes or gaps in the system also helps build an edge over competitors.
  8. Documentation for ensuring efficiency and eliminating risks.
  9. Determining ways to monetize through a specific model while aiming to achieve consistent revenue growth. 
  10. Leveraging feedback from users, customers, and experts.  

Frequently Asked Questions (FAQs)

How many business models are there?

Business models differ from business to business based on their costs and pricing and the kind of supply chain they follow. However, a few prominent ones are subscriptions, fee-for-service, retail, manufacturing, etc. 

Why are business models important? 

They are important as they help businesses break even or overcome costs by earning higher revenues. Thus, a business model works as a guide, but changing it with changing business environments is also important. 

How to compare business models? 

These are comparable based on business model components such as monetization of a business, target audience, business competitors, costs and pricing strategy, sustainability, and value propositions.  

What are digital business models? 

Digital business models or e-commerce models are those which use information and technology as a medium to provide goods and services to their customers. Some popular digital models for business include freemium services, subscription-based models, white labeling, wholesaling, and warehousing.

This article has been a guide to What are Business Models & their meaning. We discuss its components, types, retail, circular, and innovative models with examples. You can learn more from the following articles –

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