More About Business Model

A business model is a framework for creating economic, social, and/or other forms of value. The term business model is thus 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.

Conceptualization of business models try to formalize informal descriptions into building blocks and their relationships. While many different conceptualizations exist, Osterwalder proposed^[1] a synthesis of different conceptualizations into a single reference model based on the similarities of a large range of models, and constitutes a business model design template which allows enterprises to describe their business model:

Infrastructure

• Core capabilities: The capabilities and competencies necessary to execute a company's business model.
• Partner network: The business alliances which complement other aspects of the business model.
• Value configuration: The rationale which makes a business mutually beneficial for a business and its customers.

Offering

• Value proposition: The products and services a business offers. Quoting Osterwalder (2004), a value proposition "is an overall view of .. products and services that together represent value for a specific customer segment. It describes the way a firm differentiates itself from its competitors and is the reason why customers buy from a certain firm and not from another."

Customers

• Target customer: The target audience for a business' products and services.
• Distribution channel: The means by which a company delivers products and services to customers. This includes the company's marketing and distribution strategy.
• Customer relationship: The links a company establishes between itself and its different customer segments. The process of managing customer relationships is referred to as customer relationship management.

Finances

• Cost structure: The monetary consequences of the means employed in the business model. A company's DOC.
• Revenue: The way a company makes money through a variety of revenue flows. A company's income.

To extract value from an innovation, a start-up (or any firm for that matter) needs an appropriate business model. Business models convert new technology to economic value. Business model is a method of doing business by which a company can generate revenue to sustain itself. Its also spells out where the company is positioned in the value chain.

For some start-ups, familiar business models cannot be applied, so a new model must be devised. Not only is the business model important, in some cases the innovation rests not in the product or service but in the business model itself.
Business models are a component of a business plan or a business case. In their paper, The Role of the Business Model in Capturing Value from Innovation, Henry Chesbrough and Richard S. Rosenbloom present a basic framework describing the elements of a business model.
Given the complexities of products, markets, and the environment in which the firm operates, very few individuals, if any, fully understand the organization's tasks in their entirety. The technical experts know their domain and the business experts know theirs. The business model serves to connect these two domains as shown in the following diagram:
Role of Business Model

Technical Inputs

Business Model

Economic Outputs

A business model draws on a multitude of business subjects, including economics, entrepreneurship, finance, marketing, operations, and strategy. The business model itself is an important determinant of the profits to be made from an innovation. A mediocre innovation with a great business model may be more profitable than a great innovation with a mediocre business model.

In their research, Chesbrough and Rosenbloom searched literature from both the academic and the business press and identified some common themes. They list the following six components of the business model:

1. Value proposition - a description the customer problem, the product that addresses the problem, and the value of the product from the customer's perspective.
2. Market segment - the group of customers to target, recognizing that different market segments have different needs. Sometimes the potential of an innovation is unlocked only when a different market segment is targeted.
3. Value chain structure - the firm's position and activities in the value chain and how the firm will capture part of the value that it creates in the chain.
4. Revenue generation and margins - how revenue is generated (sales, leasing, subscription, support, etc.), the cost structure, and target profit margins.
5. Position in value network - identification of competitors, complementors, and any network effects that can be utilized to deliver more value to the customer.
6. Competitive strategy - how the company will attempt to develop a sustainable competitive advantage, for example, by means of a cost, differentiation, or niche strategy.

Business Model vs. Strategy
Chesbrough and Rosenbloom contrast the concept of the business model to that of strategy, identifying the following three differences:

1. Creating value vs. capturing value - the business model focus is on value creation. While the business model also addresses how that value will be captured by the firm, strategy goes further by focusing on building a sustainable competitive advantage.
2. Business value vs. shareholder value - the business model is an architecture for converting innovation to economic value for the business. However, the business model does not focus on delivering that business value to the shareholder. For example, financing methods are not considered by the business model but nonetheless impact shareholder value.
3. Assumed knowledge levels - the business model assumes a limited environmental knowledge, whereas strategy depends on a more complex analysis that requires more certainty in the knowledge of the environment.

Structure of Business Models
All business models must specify their revenue model (the description of how the company or an E-Commerce project will earn revenue). Revenue sources are:

• Transaction fees
• Subscription fees
• Advertisement fees
• Affiliate fees
• Sales
• Other models

Value proposition is the description of the benefits a company can derive from using E-Commerce.

References

1. Alexander Osterwalder, The Business Model Ontology - A Proposition In A Design Science Approach, Thesis, 2004.
2. Malone et al., Do Some Business Models Perform Better than Others?, May 2006.