The components of a business model

As we discussed in our last post, a business model is a blueprint for the business, outlining how you’re going to run your business, and how you’re going to make money. It’s made up of five elements:

  • Business concept
  • Value chain position
  • Calculating customer value
  • Revenue sources and cost drivers
  • Competitive advantage

Let’s take a closer look at each one.

Business concept

A business concept is essentially a clear description of your business. It’s made up of:

Value chain position

Understanding the value chain, or more specifically, your business’ position in the value chain, is critical to further understanding your business on a larger scale.

A value chain is the series of activities that make products and services get from you to the end user. As products and services pass through the value chain, they gain value. For example, a leather bag involves researching the best design; designing the bag; sourcing leather; creating a prototype; tweaking the design; creating the final version of the bag; adding details such as pockets, straps or hardware; and packaging the bag for sale. All of these steps add value to the finished product.

In a value chain, there are two flows of activities: i) Upstream activities, involving the production or manufacturing of a product or service; and ii) Downstream activities which are associated with selling or marketing of the product or service, distribution of the product or service to the end user, product warranty and customer service.

If you’re going to operate a service business, your value chain is shorter because there is no manufacturing process. Most services are delivered directly to the customer only through downstream value chain activities like marketing, sales and distribution.

Where will your business sit in the value chain? Where can you add value for your customer along the way?

Calculating customer value

Are you 100% positive of the value you can bring your customers? Or are you only about 70% positive? It’s important to estimate the value of the tangible benefits your customers will receive through the purchase of your product or service.

After all, customers today are presented with a bewildering range of value and choice of products and services. They can shop for benefits and can buy from virtually any company worldwide. Figure out how exactly they will benefit from choosing you.

What does your customer value? What actual benefits will they get from doing business with you instead of your competitors? Once you understand customer value, you can better estimate what people will pay for your product or service.

Revenue sources and cost drivers

Next, it’s time to identify revenue sources and cost drivers (any activity that causes a cost to be incurred). A very healthy business model always has several sources of revenue from many different types of customers and multiple products and services. Diversification is good!

With multiple revenue streams, you not only reduce risk, but you also create several sources of income. If one revenue source isn’t doing so well, you have other sources to keep you going. Offering multiple products to multiple types of people also means you spread out your risks and minimize the costs of marketing and acquiring new customers.

Now – cost drivers. The most common ones are volume and time. The cost of an activity increases as more units are produced and the longer it takes to complete. For example, increased sales may also mean you have to hire a new employee – increasing your HR costs.

What are your cost drivers? How they can be improved and made more efficient?

Competitive advantage

Your business has a competitive advantage when customers believe you offer clearly superior products and service from your competitors. Craft a competitive strategy, which considers how your business will compete against others — either by being different, or by serving a niche market where there are no other competitors.

Why not just copy what others are doing? It seems like a good idea, but it can also get you into trouble. Why would customers buy from you if you’re the same as your competitor — one your customers already have history with?

Crafting a competitive advantage and clearly communicating your advantage to the customer will lower their risk and make them at least think about buying from you instead.

Small businesses can serve niche markets, or smaller markets with unsatisfied needs. For example, maybe your market research suggested that there were plenty of wedding cake bakeries in your area, but customers were complaining about not being able to find vegan or gluten-free wedding cakes. Sense a competitive advantage there?

Small businesses can change quickly; they can respond to changing market conditions faster than larger businesses, making them better able to satisfy customers. Understanding how your business will compete against the competition will help you stand out.

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Goodbye Sprouter

We’ve all heard the small business failure statistics – that one half of all start-ups disappear before the end of year two. Knowing the odds are stacked against us as entrepreneurs doesn’t make it any easier to accept the loss of a great business. On August 2, Sprouter, a community-based networking and mentorship site for start-ups around the world, will be shut down due to “capital constraints.”

Sprouter founders Sarah Prevette and Erin Bury had a great idea and launched a company. For two years they’ve been satisfying a tremendous need in the marketplace for free advice, networking and information for entrepreneurs in the early stages of their business. The problem was Sprouter was hard to monetize. When you give everything away for free, where does your revenue come from? For many online companies, revenue is generated by selling ad space, referral commission (affiliates), or posting paid links. The importance of developing a sound monetization strategy from the get-go can’t be underestimated. After all, if you can’t monetize your business, you don’t have a business.

This issue came up on Wednesday’s episode of BNN’s The Pitch, where I was a panelist. One pitcher had monetized his company and the other had not. Guess which pitch won over me and my other panelists, John Sleeman and Brad Nathan? Your monetization strategy – or how you’re going to generate revenue – needs to be well-planned and researched well before launch. Of course, expect those plans to change as you go through start-up, but it’s important to at least have a plan that works on paper first.

To our friends at Sprouter, we will miss you but we know you’re serial entrepreneurs and you’ll make a triumphant return.


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