A viable Business Model is critical for building a sustainable company: in rare cases, investors may bet on ‘buying’ customers in the early stages of growth by investing in product development without worrying about revenues - but the need to build a sustainable company will catch up with you eventually.
There are many books and articles written about business models, but at the most basic level, a business model can be defined as ‘how the company plans to make money’.
Business Model development is a trade-off between external and internal influences.
We define these as vectors in The Triple Chasm Model. Part of the problem with clearly defining business models arises because the subject is often confused with other external and internal vectors. For example, the popular book on business model generation by Osterwalder and Pigneur focuses on the creation of the Business Model Canvas(1) which actually says little about business models but conflates the discussion with market spaces and focuses on the creation of new value chains. Other publications focus on the mechanics of business model creation and hence focus on the importance of sophisticated spreadsheets to model the business, which can also miss the mark.
In our view, the best description of a business model is that proposed by Teece(2) which states that
‘A Business Model articulates the logic and provides data and other evidence that demonstrates how a business creates and delivers value to customers. It also outlines the architecture of revenues, costs and profits associated with a business enterprise’
Making sense of this definition requires an explanation of what Teece means by architecture, which is best done using a simple analogy:
If we think of the construction of a building, then the architecture would refer to the ‘design’ of the building, where, for example, the architect will decide on the overall shape and configuration of the building, specifying the foundations, the roof structure, the number of rooms, the number of windows and doors. In this context then, the architecture refers to the components of the business model, and how they are configured together.
A comprehensive description of a business model needs to cover the following components:
The Overall Narrative, which includes the target marketspace and customers and the customer proposition;
Revenues, including primary, secondary and distribution-adjusted revenues;
Costs, including materials and technology costs, people costs, and ‘third party’ costs such as premises;
Revenue & Cost Allocation, including the architecture, logic, dependencies, and metrics;
Margins, including product and service margins, time variations in margins and cash flow;
Funding, including customer revenues, debt and equity;
Scenario Modelling, including the base case and pessimistic and optimistic scenarios; and
Balance Sheet Assets, including IP, hard and soft assets.
At the earlier stages, companies can focus on creating the product or service without worrying unduly about the eventual business model, but the successful crossing of Chasm II requires the development of a sustainable business model. This is one of the primary reasons for the high failure rates around Chasm II.
Contrary to popular belief, getting this right can take time. Our research based on over 3,000 companies showed that companies can frequently go thorough 5 or 6 iterations before they get this right.
All the business books which talk about pivots and needing a Plan B usually under-estimate this problem-something that companies need to be aware of when talking to investors-be careful not to lock yourself into a corner with what you promise about your business model.
Osterwalder, A and Pigneur, Y (2010), Business Model Generation, John Wiley & Sons.
Teece, D. J. (2010), Business Models, business strategy and innovation, Long Range Planning, 43, 172-194