Compiled from various sources by Prof S K Palekar in July 2014 for class room use in marketing / strategy subject

What is a “Business Model”?

Why study business models ? When you ask a question “what business are you in?”; we get a wide variety of answers :

1) “We are in watch business”

(What products we make / sell)

2) “We supply surgical consumables to hospitals”

( What kind of customers we service)

3) “We are wholesalers of steel”

( What type of distribution channel we have)

4) “We take long term recruitment contracts”

( What type of customer engagement)

5) “We provide turnkey solutions for water purification”

( What solutions we create)

6) “We are specialized in small batch manufacturing of high precision mechanical parts”

(What Capabilities we possess)

7) “We are an association of all small and medium enterprises in UP”

(The Network we provide access to)

8) “We have the lowest cost call center”

(What is our cost structure)

9) “We provide loans for buying luxury cars to high net worth people”

(Where does our revenue come from)

All of these , individually, are valid ways of describing your business but none of them are

capable of describing your business properly. For example, if you are in “watch business”, so are

many other companies – and are all these companies comparable to you ? Most probably not.

Hence you are in “watch business” is obviously an incomplete description of your business.

In this article we create a brief, and yet complete, definition of what business are you in.

Because only when you understand your own business model well, will you be in position to

Know which companies to benchmark against

Understand whether you are buying assets which support your business model

Know if your activities and spends strengthen your business model

Definition of what is a business model

It is the totality of how a company selects its customers, defines and differentiates its

offerings, defines the tasks in its value chain, decides which ones of these will it perform

itself and which ones it will outsource, configures its resources, goes to market, creates

utility for customers and captures profits.

The Business models are effective tools used by senior leaders to create narratives / stories in

order to communicate business strategy, create alignment and create a common context for

Compiled from various sources by Prof S K Palekar in July 2014 for class room use in marketing / strategy subject

action for outsiders as well as insiders. There is no one single correct way of expressing a

business model. People use formal as well as informal language and include vision, mission,

purpose, process, target customers, offerings, strategies, infrastructure, organizational structures,

operational processes etc as appropriate.

Some famous business models have been

1950 : McDonald's, Toyota

1960 : Wal-Mart, Hypermarkets

1970 : FedEx, Toys R

1980 : Home Depot, Intel, Dell

1990 : Southwest Airlines, Netflix, eBay, Amazon, Starbucks

2 Broad Models : “Pipes” to “Platforms” Pipes “Pipes” are traditional linear business models where the company “buys” materials from the

vendors (who are upstream to the company) for converting them into products or services which

are “sold” to the customers (who are downstream to the company).

The company is the main actor

which is responsible for buying materials from the vendors

which arranges resources / competencies for converting these into output

and then earning money by finding and selling the output to the customers .

Platforms “Platforms” do not have vendors and customers. Instead they have members and participants.

The company is not the main actor – it is merely an enabling mechanism (like a club)

The company creates the mechanism / rules for its members to meet and interact directly

So that each member can find another suitable member who can create value for him

The value creating transactions take place direct between two members

The company earns money by charging a commission or a fee

Example of platforms are

Clubs ( Metro is a “buying club” of cash and carry retailers )

Portals ( Members of “Shaadi.com” enables men to find wives and girls to find husbands)

Stock Exchanges ( Members can buy and sell shares using the infrastructure provided)

Retail Malls (Customers come and by directly from member retailers inside the mall)

Theatres ( Viewers and players come together to see / act a play)

Industrial Parks (Export processing zones : members share exporting facilities)

Software systems (Android hardware, software developers and customers come together)

Compiled from various sources by Prof S K Palekar in July 2014 for class room use in marketing / strategy subject

The platform models have come to the fore from 2000 onwards due to new technologies like

Web 2.0, collective intelligence, crowd-sourcing, network effects, user generated content, and

continuously self-improving systems.

Buyers and Sellers : Alibaba.com, eBay, Taobao, Rakuten, Exhibitions

Flyers and Air Lines : Airports

Dwelling Owners and Renters : Airbnb

Professional drivers and passengers : Uber Apps

Users, advertisers, content developers, third-party sites : Facebook

Application developers and users : Apple’s iOS

Handset makers, app developers and users : Google’s Android OS

Game developers and users : Sony’s PlayStation, Microsoft’s Xbox

Merchants and Customers : American Express, PayPal and Square

Retail stores and consumers : shopping malls

Cinemas and Viewers : Fandango

Event Venues and Consumers : Ticketmaster .

20 Examples of Business Models

1) Bricks and clicks business model : a company integrates both offline (bricks) and online

(clicks) presences. For example, when a chain of stores allows the user to order products

online, but lets them pick up their order at a local store.

2) Cutting out the middleman model : Instead of going through traditional distribution

channels - distributors, wholesalers, brokers, agents, retailers – the company deals with

every customer directly for example via the Internet.

3) Direct sales model : Involves selling to consumers directly - away from a fixed retail

location. Sales are typically made through party plan, one-to-one demonstrations, and other

personal contact arrangements. Direct personal presentation, demonstration, and sale of

products and services to consumers, usually in their homes or at their jobs.

4) Value-added reseller model : A business makes something which is resold by other

businesses but with modifications which add value to the original product or service. These

modifications or additions are mostly industry specific in nature and are essential for the

distribution.

5) Franchise Model : Franchising is the practice of using another firm's successful business

model. For the franchisor, the franchise is an alternative to building 'chain stores' to distribute

goods and avoid investment and liability over a chain. The franchisor's success is the success

of the franchisees. The franchisee is said to have a greater incentive than a direct employee

because he or she has a direct stake in the business.

6) Freemium business model : A common model on web sites, colloquially becoming known

as the freemium model, is to provide content for free, but restrict access to premium features

Compiled from various sources by Prof S K Palekar in July 2014 for class room use in marketing / strategy subject

(for example, archives) to paying subscribers. In this case, the subscriber-only content is said

to be “behind a paywall”.

7) Performance Servicing Model : Here what is sold is the performance and not the product.

For example, the painting of roads is the basis of the number of kilometers to be covered and

not the number of liters of paint used. This concept is also called “product-service systems",

"chemical servicing" or “performance servicing”.

8) Loyalty business models : Company resources are employed so as to increase the loyalty of

customers which leads to customer satisfaction, which in turn leads to customer loyalty,

which leads to low defection and more profitability due to low acquisition costs of new

customers.

9) Low cost business model (Also called “no-frills”, “discount”, “Budget” model). It occupies

lower position on “Value for Money” curve - lower prices but lower value too. Example :

Low cost airline model : the common practices are

Standardized fleet (lower training, maintenance costs; purchasing aircraft in bulk)

Remove non-essential features (non-reclining seats, no frequent flyer schemes)

Use of secondary airports (lower landing fees, marketing support)

Rapid turnaround (less time on the ground, more flights per day)

Online ticket sales (no call centres or agents)

Online check-in (fewer check-in desks)

Impose baggage charges (fewer bags mean faster loading) (revenue for checked bags)

Do not use jet-ways (avoiding extra airport charges)

Have staff do multiple jobs (cabin crew also check tickets at the gate, clean aircraft)

Hedge fuel costs (buying fuel in advance when it is cheaper)

Charge for on-board services, reserved seating, and extra baggage

Do not use reserved seating (which slows down the loading of the aircraft)

Charge for checked bags (which slows down loading of the aircraft)

Charge for last minute baggage check-in (which slows down loading of the aircraft)

Fly point to point (passenger transfers to other flights are not accommodated)

Keep aircraft on the ground for very short time (lower airport charges)

Carry very little extra fuel (reducing the weight of the aircraft)

Have the plane outfitted with cost-cutting modifications as winglets.

Route planning before aircraft arrives at airport (saving time on the ground)

Work closely with aircraft manufacturers

Work closely with airports to develop special “low cost terminals”

Pricing policy : usually very dynamic, with discounts and tickets in promotion.

10) Premium business model : This is the opposite to the previous one : offering high end

products and services appealing to discriminating consumers. “Brand image” and “Want” is

important in this model as quality is subjective. The model seeks a higher profit margin on a

lower sales volume : Rolls-Royce, BMW, Mercedes-Benz in the auto industry, Gucci bags

and Rolex watches in the luxury accessories industry, and elite personal services such as

Compiled from various sources by Prof S K Palekar in July 2014 for class room use in marketing / strategy subject

using a chauffeur.

11) Online auction business model (If conducted by an auction house it is a “platform”

business. If conducted by an individual buyer it is a “pipe” business) : There are different

forms like “Ascending English auction”, “Descending Dutch auction”, “First-price sealed-

bid” etc. These auctions are propelled by the Internet as they remove the physical limitations

of geography, presence, time, space, and a small target audience. In 2002, online auctions

were projected to account for 30% of all online e-commerce due to the rapid expansion of the

popularity of the form of electronic commerce.

12) Online or offline cooperative (Platform Business) : An autonomous association of similar

businesses who voluntarily join together on an online platform for their mutual and

individual benefit. For example restaurants within a part of a city can create a joint portal

where the customers can log in and choose what food they want and have it delivered to them

within an hour. Such a facility will be outside the funding abilities of an individual

restaurants. The platform aspect of the cooperative allows for the unique, individual

identification of each member in the cooperative.

13) Multi-level marketing business model : (Also called pyramid selling model, network

marketing, referral marketing) where the salespersons are compensated not only for the sales

they personally generate, but also for the sales of the other salespeople that they recruit, train

and sustain. But this model has come under fire because of

a) Price fixing of products

b) High initial entry costs (for marketing kit and first products)

c) Emphasis of recruitment of others over actual sales

d) Requiring members to purchase and use the company's products

e) Exploitation of personal relationships as both sales and recruiting targets

f) Complex and exaggerated compensation schemes

g) Company / distributors making money off training events and materials

h) Cult-like techniques to enhance their members' enthusiasm and devotion.

14) Collective business models ( Platform Model) : A large numbers of businesses who pool

resources, share information, provides other benefits for their members. For example : all

export oriented units find it convenient to have all resources available for export business like

banks to open LCs, library stocked with latest rules, satellite dish to connect to overseas

customers, on site presence of customs officers, quick access to port and airport facilities etc.

15) Network effects business model (Typically a “Platform” model ): The value of a product

or service is dependent on the number of others using it. Example : The more the people

own telephones the more is the value of a new connection to the new owner. A user may

purchase a telephone without intending to create value for other users, but he does. Social

networking sites like Twitter and Facebook become more useful as more users join.

16) Professional open-source model : In software business, open-source vendor generates

revenue from paid professional services, maintenance and support provided along with the

software. Businesses hesitated to adopt Linux because no single entity guaranteed its

Compiled from various sources by Prof S K Palekar in July 2014 for class room use in marketing / strategy subject

stability and support. As a consequence, larger businesses often chose commercially

distributed software over a product that was released under an open-source license. The

business model of these companies tries "to offer open-source software with a free license,

while using professional services, maintenance and support for these products to derive

revenue."

17) Free Lunch Model : In the early 1900s, you could get a “free" lunch with the purchase of at

least one drink in some US salons. The saloon-keeper relied on the expectation that most

customers would buy more than one drink, and that the practice would build patronage for

other times of day.

18) Razor and blades business model : Example of “Hook and Bait ” model “ “we are here to

somehow sell “the hook” once so that the person will keep on buying “the baits” for the rest

of the life”.

razor (bait) and blades (hook)

cell phones (bait) and air time (hook)

computer printers (bait) and ink cartridge refills (hook)

cameras (bait) and prints (hook)

Adobe Reader : document reader is free but writer is charged.

Gillette sold razors at an artificially low price to create the market for the blades. The

company still uses this approach, often sending disposable safety razors in the mail to

young men near their 18th birthday, packaging them as giveaways at public events that

Gillette has sponsored.

Standard Oil and its owner, John D. Rockefeller, looked to China to expand their

business and gave away 8 million kerosene lamps for free or at greatly reduced prices to

increase the demand for kerosene.

Comcast often gives away DVRs to its subscribing customers. However, the cost of

giving away each free DVR is offset by a $19.95 installation fee as well as a $13.95

monthly subscription fee to use the machine. Based on an average assumed cost of $250

per DVR box to Comcast, after 18 months the loss would balance out and begin to

generate a profit.

Computer printer manufacturers have gone through extensive efforts to make sure that

their printers are incompatible with lower cost after-market ink cartridges and refilled

cartridges. This is because the printers are often sold at or below cost to generate sales of

proprietary cartridges which will generate profits for the company over the life of the

equipment. In fact, in certain cases, the cost of replacing disposable ink or toner may

even approach the cost of buying new equipment with included cartridges, although

included cartridges are often 'starter' cartridges that are only partially filled.

Methods of vendor lock-in include designing the cartridges in a way that makes it

possible to patent certain parts or aspects to prohibit reverse engineering by third-party

ink manufacturers. Another method entails completely disabling the printer when a non-

proprietary ink cartridge is placed into the machine, instead of merely issuing an

ignorable message that a non-genuine (yet still fully functional) cartridge was installed.

19) Servicization of products model : Many products are being transformed into services. For

example, IBM treats its business as a service business. Although it still manufactures

Compiled from various sources by Prof S K Palekar in July 2014 for class room use in marketing / strategy subject

computers, it sees the physical goods as a small part of the "business solutions" industry.

They have found that the price elasticity of demand for "business solutions" is much less than

for hardware. There has been a corresponding shift to a subscription pricing model. Rather

than receiving a single payment for a piece of manufactured equipment, many manufacturers

are now receiving a steady stream of revenue for ongoing contracts.

20) Subscription business model : The subscription business model is a business model where a

customer must pay a subscription price to have access to the product/service and was

pioneered by magazines and newspapers but is now used by many businesses and websites.

Rather than selling products individually, a subscription sells periodic access to a product.

Opera companies sell tickets to the entire run of five to fifteen scheduled performances for an

entire season. Industries that use this model include mail order book sales clubs and music

sales clubs, cable television, satellite television providers with pay-TV channels, satellite

radio, telephone companies, cell phone companies, internet providers, software providers,

business solutions providers, financial services firms, fitness clubs, and pharmaceuticals, as

well as the traditional newspapers, magazines and academic journals. Renewal of a

subscription may be periodic and activated automatically, so that the cost of a new period is

automatically paid for by a pre-authorized charge to a credit card or a checking account.

Summary

There are many advantages of being able to define your business model briefly yet comprehensively. Because, an explicitly defined model permits you

To know which companies to benchmark against

To know whether you are buying assets which support your business model

To know if your activities and spends strengthen your business model

To narrate your story to outsiders and insiders to create alignment When creating your business model you may include any of the following as relevant to your main purpose

Type of Products / Services / Solutions

Type of customers

Type of distribution channels

Type of customer engagement and relationships

Type of capabilities

Type of cost structures

Type of revenue streams