Why Should All Leaders Understand the Organization’s Business Model?
Many leaders know what a business strategy or plan is all about, and may have written or contributed to one, but when asked the question “what is the organization’s business model?” many struggle to come up with a good answer. Although there are several ways to define it, a Business model is an overall approach used to acquire customers, provide service to them in some way and make money from doing so. If you put this definition into questions, this translates into:
- What will you offer that is of value to customers?
- How will you sustainably offer your services to them?
- How will you make money from your activities, or monetize the process?
These simple questions can be addressed by a business plan. However, a business plan is mostly concerned with building a tactical approach to make money, often at a highly detailed level including marketing, operational and financial plans and projections. This is therefore more about “how” to operate a business in a step-by-step way.
A business model, on the other hand, aims to simply describe the process by which the overall business seeks to operate from the outset in a more strategic, “big-picture” or conceptual way. It is therefore more about “what” the business is trying to do and why. A well-thought-through business model should therefore precede the writing of a business plan.
The need to have a sound business model may appear to be a very recent concept but, in fact, has been around from the age of the industrial revolution in the late 18th/early 19th century and grown quickly in importance since then. In the early days, individuals started to realize that there was more than one way to approach a market and then make money accordingly. Factors to consider then and now were issues such as the size and needs of the market, where people are based, their capacity to pay, the amount of up-front investment needed to serve the needs of customers, the cost of supplying or delivering to customers, the availability of particular skills and knowledge to render products and services, competition levels, sustainability of the consumer needs over time, risks in general and many other factors. These are still relevant today. In the 21st century, other issues also play an important part in business model formation including technology and innovation factors, legislative and/or political constraints, the need for careful customer segmentation, business agility to handle rapid change, pricing flexibility, and the ability to build an attractive brand etc.
So what different kinds of business models are there?
There are clearly a vast number of very different business models in the world (at the detailed level) if we looked at what it is that makes each enterprise and its offerings unique (often called the unique value proposition). However, it is possible to cluster a number of broadly similar business models and as a result, in the list below are eight that can be clearly described:
1. Build it once and resell over and over again
This has been one of the most popular business models for decades, especially when capital investment is high at the outset. Setting up a manufacturing assembly-line for a single product, buying equipment to mine raw materials, writing a single software program (such as a company like Intuit did when it wrote the accounting package “QuickBooks”) or operating as a one person consultant selling the same service (like a standard audit for example) are all examples of this business model. This model has great scale potential but needs lots of customers to sell to over a long time for it to work sustainably.
2. Build a great brand
Although it takes time to establish it and get customers to be loyal, a good/popular product or service brand business model can allows an enterprise to charge customers a premium. Many consumer products fall into this category, with Apple being a popular modern example of the leverage and premium price and revenues to be enjoyed as a result of loyalty to the brand. “Brand equity” can also be established in personal service firms such as some doctors, lawyers and home decorators (which is usually built around the expertise, knowledge and even the “likability” of the owner).
3. Invent something and protect it legally
Many companies have a great or different idea at their core (whether they discovered this idea by accident or by design) and can seek ways to protect it in order to profit from it under this business model. This may be done by patents, trademarks and copyrights legally but this may also be done by keeping a design, configuration, recipe or formula secret so that competitors can’t easily copy it. Microsoft DOS and Xerox Docu-Tech copiers are examples of companies enjoying legal protections in the past while Kentucky Fried Chicken or Coca-Cola are examples of so-called “secret” knowledge which is carefully guarded.
4. Be the lowest cost provider
It may seem obvious that all organizations should control costs to be as low as possible but this is not the same as choosing to be the lowest cost provider in your market or segment as part of your business model. This involves creating the same product or service but using the cheapest ways of producing it (which may mean cheap materials, lower wages to employees or even less profit margin (meaning that overhead costs have to be low also). Wal-Mart is a good example of this in the retail sector or South-West Airlines in the air travel industry.
5. Introduce a disruptive technology or approach
A disruptive approach or technology is only possible as a business model when you have the scope to do it (meaning that it typically only works in part of the market). However, there are many relatively “complacent” industries and sectors that either have few competitors and/or have not seen much innovation in them in recent times. In these circumstances, a newly developed technological or internet-based technology or much lower price process can be highly disruptive. The web site Craigslist is a good example of this in relation to the long-standing small newspaper adverts industry and so is Netflix, whose mail order and streaming movies quickly helped drive Blockbuster Video out of business.
6. Sell quality
Many people want higher quality or more prestigious goods and services and will pay a premium for it under this business model. Selling quality is often associated with luxury products such as a Rolls-Royce car or a Rolex watch, for example, but can equally be the best-in-class for much less costly products and services of all kinds (such as a Kobe Burger as an alternative to a standard fast-food burger, for example). There are many examples of companies using this business model including Häagen-Dazs ice-cream, Starbucks coffee or Coach hand-bags.
7. Be a niche player
A niche is a micro-segment of the market and is much more possible to identify and serve than ever in the modern age of the Internet. A niche may be a small segment of a product or service market but well-beyond a particular geography, for example. For example, instead of selling shoes a company may elect to only sell shoe-laces but do so in a much more differentiated way with alternatively available lengths, colors, thicknesses etc. The author Chris Anderson popularized the concept of “the long-tail” in this category. He suggested that although a few companies will dominate the most popular and mass market products or services, there is a long-tail of niches in almost every market in which businesses can often make very good and long-term returns.
8. Individual customization
In recent years it has become possible to tailor product and service offerings much more than ever. In other words, instead of the Henry Ford idea of mass-production of the model T-car thinking (one single product supplied to all customers), this business model allows for a high level of end-user customization. Many coffee-shops now sell massive drink-tailoring potential with milk variations, syrup additives, relative levels of hotness, different coffee shots, foam-levels etc., for example. Other good examples of this tailored business model are operated by spa companies, computer laptop suppliers and single item furniture-makers. All of these can attract a premium for these higher levels of customization.
These are clearly not the only business models in popular use but they give some idea of the wide variety that exists and there are many variations on the above general themes, of course.
So why do all Leaders need to understand the organization’s business model?
Every commercial enterprise comes into being with a business model of some kind, even if it is a poor one. But in these fast-changing times in particular, we need to be much more vigilant than ever about whether or not our business model is working as well as it should (or even may be slowly “running out of steam”). Put another way, if a current business model is slowing down, not attracting enough customers or not generating enough margins to be profitable, then a change is called for. Although a business CEO may be the first to identify the problem, everyone in a leadership role across the organization has the capacity to spot important market or trend changes and to start thinking about an adjustment or even an entirely new forward business model path. This may well be the most critical issue to be vigilant about in the future, even when great success has been experienced in the past, and we therefore need as many eyes on the issue as possible. In this way, we apply our optimization effort at the highest possible level and create impetus for other optimizations and/or interventions to then be made over time.