Business model

A business model describes the rationale of how an organization creates, delivers, and captures value^[1] (economic, social, cultural, or other forms of value). The process of business model construction is part of business strategy.

In theory and practice the term business model is used for a broad range of informal and formal descriptions to represent core aspects of a business, including purpose, offerings, strategies, infrastructure, organizational structures, trading practices, and operational processes and policies. The literature has provided very diverse interpretations and definitions of a business model. A systematic review and analysis of manager responses to a survey defines business models as the design of organizational structures to enact a commercial opportunity.^[2] Further extensions to this design logic emphasize the use of narrative or coherence in business model descriptions as mechanisms by which entrepreneurs create extraordinarily successful growth firms.^[3]

Whenever a business is established, it either explicitly or implicitly employs a particular business model that describes the architecture of the value creation, delivery, and capture mechanisms employed by the business enterprise. The essence of a business model is that it defines the manner by which the business enterprise delivers value to customers, entices customers to pay for value, and converts those payments to profit: it thus reflects management’s hypothesis about what customers want, how they want it, and how an enterprise can organize to best meet those needs, get paid for doing so, and make a profit.^[4]

Business models are used to describe and classify businesses (especially in an entrepreneurial setting), but they are also used by managers inside companies to explore possibilities for future development. Also, well known business models operate as recipes for creative managers.^[5] Business models are also referred to in some instances within the context of accounting for purposes of public reporting.

History

Over the years, business models have become much more sophisticated. The bait and hook business model (also referred to as the "razor and blades business model" or the "tied products business model") was introduced in the early 20th century. This involves offering a basic product at a very low cost, often at a loss (the "bait"), then charging compensatory recurring amounts for refills or associated products or services (the "hook"). Examples include: razor (bait) and blades (hook); cell phones (bait) and air time (hook); computer printers (bait) and ink cartridge refills (hook); and cameras (bait) and prints (hook). A variant of this model is Adobe, a software developer that gives away its document reader free of charge but charges several hundred dollars for its document writer.

In the 1950s, new business models came from McDonald's Restaurants and Toyota. In the 1960s, the innovators were Wal-Mart and Hypermarkets. The 1970s saw new business models from FedEx and Toys R Us; the 1980s from Blockbuster, Home Depot, Intel, and Dell Computer; the 1990s from Southwest Airlines, Netflix, eBay, Amazon.com, and Starbucks.

Today, the type of business models might depend on how technology is used. For example, entrepreneurs on the internet have also created entirely new models that depend entirely on existing or emergent technology. Using technology, businesses can reach a large number of customers with minimal costs.

Theoretical and empirical insights to business models

Design Logic and Narrative Coherence

Design logic views the business model as an outcome of creating new organizational structures or changing existing structures to pursue a new opportunity. Gerry George and Adam Bock (2011) conducted a comprehensive literature review and surveyed managers to understand how they perceived the components of a business model. In that analysis, these authors show that there is a design logic behind how entrepreneurs and managers perceive and explain their business model. In further extensions to the design logic, George and Bock (2012) use case studies and the IBM survey data on business models in large companies to describe how CEOs and entrepreneurs create narratives or stories in a coherent manner to move the business from one opportunity to another. They also show that when the narrative is incoherent or the components of the story are misaligned that these businesses tend to fail. They recommend ways in which the entrepreneur or CEO can create strong narratives for change.

Business Model 2.0

Chen (2009) pointed out that the business model in the twenty-first century has to take into account the capabilities of Web 2.0, such as collective intelligence, network effects, user generated content, and the possibility of self-improving systems. He suggested that the service industry such as the airline, traffic, transportation, hotel, restaurant, Information and Communications Technology and Online gaming industries will be able to benefit in adopting business models that take into account the characteristics of Web 2.0. He also emphasized that Business Model 2.0 has to take into account not just the technology effect of Web 2.0 but also the networking effect. He gave the example of the success story of Amazon in making huge profits each year by developing a full blown open platform that supports a large and thriving community of companies that re-use Amazon’s On Demand commerce services.^[6]

Complementarities of business models between partnering firms

Studying collaborative research and the accessing of external sources of technology, Hummel et al. (2010) found that in deciding on business partners, it is important to make sure that both parties’ business models are complementary.^[7] For example, they found that it was important to identify the value drivers of potential partners by analyzing their business models, and that it is beneficial to find partner firms that understand key aspects of our own firm’s business model.^[8]

Applications

Malone et al.^[9] at MIT found that some business models, as defined by them, indeed performed better than others in a dataset consisting of the largest U.S. firms, in the period 1998 through 2002, while they did not prove whether the existence of a business model mattered.

In the context of the Software-Cluster, which is funded by the German Federal Ministry of Education and Research, a business model wizard for software companies has been developed. It supports the design and analysis of software business models. The tool's underlying concept and data were published in various scientific publications.^[10]

The concept of a business model has been incorporated into certain accounting standards. For example, the International Accounting Standards Board (IASB) utilizes an "entity's business model for managing the financial assets" as a criterion for determining whether such assets should be measured at amortized cost or at fair value in its financial instruments accounting standard, IFRS 9.^{[11][12][13][14]} At least two members of the U.S. based Financial Accounting Standards Board (FASB) have expressed the position that the business model of an entity should be used as a criterion for the classification of financial liabilities.^[15] The concept of business model has also been introduced into the accounting of deferred taxes under International Financial Reporting Standards with 2010 amendments to IAS 12 addressing deferred taxes related to investment property.^[16][17][18]

Both IASB and FASB have proposed using the concept of business model in the context of reporting a lessor's lease income and lease expense within their joint project on accounting for leases.^[19][20][21] The concept has also been proposed as an approach for determining the measurement and classification when accounting for insurance contracts.^[22][23] As a result of the increasing prominence the concept of business model has received in the context of financial reporting, the European Financial Reporting Advisory Group (EFRAG), which advises the European Union on endorsement of financial reporting standards, commenced a project on the "Role of the Business Model in Financial Reporting" in 2011.^[24]

Examples of Business models

In the early history of business models it was very typical to define business model types such as bricks-and-mortar or e-broker. However, these types usually describe only one aspect of the business (most often revenue model). Therefore, more recent literature on business models concentrates on describing business model as a whole instead of one most visible aspects.

The following exampless provide an overview for various business model types that have been in discussion since the invention of term business model:

• Bricks and clicks business model

Business model by which a company integrates both offline (bricks) and online (clicks) presences. One example of the bricks-and-clicks model is when a chain of stores allows the user to order products online, but lets them pick up their order at a local store.

• Collective business models

Business organization or association typically composed of relatively large numbers of businesses, tradespersons or professionals in the same or related fields of endeavor, which pools resources, shares information or provides other benefits for their members.

• Cutting out the middleman model

The removal of intermediaries in a supply chain: "cutting out the middleman". Instead of going through traditional distribution channels, which had some type of intermediate (such as a distributor, wholesaler, broker, or agent), companies may now deal with every customer directly, for example via the Internet.

• Direct sales model

Direct selling is marketing and selling products 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. A text book definition is: "The direct personal presentation, demonstration, and sale of products and services to consumers, usually in their homes or at their jobs."^[25]

• Distribution business models, various
• Fee in, free out

Business model which works by charging the first client a fee for a service, while offering that service free of charge to subsequent clients.

• Franchise

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.

• Freemium business model

Business model that works by offering basic Web services, or a basic downloadable digital product, for free, while charging a premium for advanced or special features.^[26]

Other examples of business models are:

• Auction business model
• All-in-one business model
• Chemical Leasing
• Low-cost carrier business model
• Loyalty business models
• Monopolistic business model
• Multi-level marketing business model
• Network effects business model
• Online auction business model
• Online content business model
• Premium business model
• Professional open-source model
• Pyramid scheme business model
• Razor and blades business model
• Servitization of products business model
• Subscription business model

Business model frameworks

Technology centric communities have defined "frameworks" for business modeling. These frameworks attempt to define a rigorous approach to defining business value streams. It is not clear, however, to what extent such frameworks are actually important for business planning. A state of the art review on business model frameworks can be found in Krumeich et al. (2012).^[27] In the following some frameworks are introduced.

• Business reference model

Business reference model is a reference model, concentrating on the architectural aspects of the core business of an enterprise, service organization or government agency.

• Component business model

Technique developed by IBM to model and analyze an enterprise. It is a logical representation or map of business components or "building blocks" and can be depicted on a single page. It can be used to analyze the alignment of enterprise strategy with the organization's capabilities and investments, identify redundant or overlapping business capabilities, etc.

Although Webvan failed in its goal of disintermediating the North American supermarket industry, several supermarket chains (like Safeway Inc.) have launched their own delivery services to target the niche market to which Webvan catered.

• Industrialization of services business model

Business model used in strategic management and services marketing that treats service provision as an industrial process, subject to industrial optimization procedures

• Business Model Canvas

Developed by A. Osterwalder, Yves Pigneur, Alan Smith, and 470 practitioners from 45 countries, the business model canvas ^[1][28] is one of the most used frameworks for describing the elements of business models.

Related concepts

The process of business model design is part of business strategy. The implementation of a company's business model into organisational structures (e.g. organigrams, workflows, human resources) and systems (e.g. information technology architecture, production lines) is part of a company's business operations.

It is important to understand that business modeling commonly refers to business process design at the operational level, whereas business models and business model design refer to defining the business logic of a company at the strategic level.^{[citation needed]}

The brand is a consequence of and has a symbiotic relationship with the business model since the business model determines the brand promise and the brand equity becomes a feature of the model. Managing this is a task of integrated marketing.

The standard terminology and examples of business models do not apply to most nonprofit organizations, since their sources of income are generally not the same as the beneficiaries. The term funding model is generally used instead.^[29]

See also

• Business model design
• Business plan
• Business process modeling
• Business reference model
• Business rule
• Competitive advantage
• Core competency
• Growth platforms
• Market forms
• Marketing
• Marketing plan
• Strategic management
• Strategic planning
• Strategy dynamics
• Value migration
• The Design of Business

Further reading

• Analyzing the Business Model Concept — A Comprehensive Classification of Literature, T. Burkhart, J. Krumeich, D. Werth, and P. Loos, Proceedings of the International Conference on Information Systems (ICIS 2011). Paper 12. http://aisel.aisnet.org/icis2011/proc eedings/generaltopics/12
• 'The Business Model: Theoretical Roots, Recent Developments, and Future Research', C. Zott, R. Amit, & L.Massa., WP-862, IESE, June, 2010 - revised September 2010 [http://www.iese.edu/research/pdfs/DI- 0862-E.pdf]
• Business Model Discovery by Technology Entrepreneurs. Steven Muegge. Technology Innovation Management Review, April 2012, pp. 5-16.
• Models of opportunity: How entrepreneurs design firms to achieve the unexpected. George, G., Bock, AJ. Cambridge University Press, 2012, ISBN 978-0-521-17084-0.
• "Special Issue on Business Models" Long Range Planning, vol 43 April 2010, that includes 19 pieces by leading scholars on the nature of business models
• The Role of the Business Model in capturing value from Innovation: Evidence from XEROX Corporation’s Technology Spinoff Companies., H. Chesbrough and R. S. Rosenbloom , Boston, Massachusetts, Harvard Business School, 2002.
• Leading the revolution., G. Hamel, Boston, Harvard Business School Press, 2000.
• Changing Business Models: Surveying the Landscape, J. Linder and S. Cantrell, Accenture Institute for Strategic Change, 2000.
• Developing Business Models for eBusiness., O. Peterovic and C. Kittl et al., International Conference on Electronic Commerce 2001, 2001.
• Place to space: Migrating to eBusiness Models., P. Weill and M. R. Vitale, Boston,Harvard Business School Press, 2001.
• Value-based Requirements Engineering - Exploring Innovative e-Commerce Ideas, J. Gordijn, Amsterdam, Vrije Universiteit, 2002.
• Internet Business Models and Strategies, A. Afuah and C. Tucci, Boston, McGraw Hill, 2003.
• Focus Theme Articles: Business Models for Content Delivery: An Empirical Analysis of the Newspaper and Magazine Industry, Marc Fetscherin and Gerhard Knolmayer, International Journal on Media Management, Volume 6, Issue 1 & 2 September 2004 , pages 4 – 11, September 2004.
• Business Model Generation, A. Osterwalder, Yves Pigneur, Alan Smith, and 470 practitioners from 45 countries, self published, 2009
• Sustaining Digital Resources: An on-the-ground view of projects today, Ithaka, November 2009. Overview of the models being deployed and analysis on the effects of income generation and cost management.
• Paul Timmers: Business Models for Electronic Markets, Electronic Markets, Vol 8 (1998) No 2, pp. 3 - 8.

References