Chapter 3

Business Models Come in Many Different Forms

In This Chapter

Finding out what all business models have in common

Perusing popular business models

Connecting well-known companies to their business models

A business model is like a lump of clay that you can mold into many different shapes and sizes. This pliability is a powerful feature, enabling entrepreneurs to craft their models to fit their business needs. Yet, despite all this potential for variety, all business models have a set of shared characteristics. These commonalities are what set business models apart from other business tools, such as business plans, strategic plans, and operational plans.

This chapter focuses on what all business models have in common. After you have the basics down, I use examples to show you aspects of all business models as well as a list of many common types of business models. By considering these examples, you can begin the creative process you need to develop your business model.

Common Aspects of All Business Models

Whether your business model is cutting edge or based on 100-year-old principles, all business models answer the following questions:

What problem are you trying to solve? People don’t need a new widget; they need the new widget to solve a problem. No one asked for an ATM. Customers wanted additional banking hours. The ATM solved this problem. Start with the job the customer is trying to accomplish, but without a good solution. These unserved or underserved markets provide the best opportunity for a great business model.

Who needs this problem solved? The answer to this question is the customer you’ll be serving. In the case of the ATM, the market is very large — everyone with a bank account. In the case of pet cloning, the market is much smaller — people with $50,000 who loved their deceased pet enough to recreate it.

What market segment is the model pursuing? A market segment is a group of prospective buyers who have common needs and will respond similarly to your marketing. Nike makes shoes for many market segments, among them running, basketball, aerobics, and hiking. Traditional marketing focuses on demographic segments while modern marketing focuses on buyer behaviors.

How will you solve this problem better, cheaper, faster, or differently than other offerings? Duluth Trading Company offers “ballroom jeans” that offer extra room in the right places so you can crouch without the ouch. Clever, unique offerings like these are superior to a better mousetrap.

What is the value proposition? What problem do you solve for the customer in relation to what you charge to fix it? Ballroom jeans have a clever niche and solve a problem for a defined segment; but if the price is $250 per pair, the value proposition would be weak. Your product solves a problem for the customer. Hopefully, the customer values the solution and will pay you much more than it costs you to make the product. The larger this spread, the greater your value proposition.

Where does your offer place you on the value chain? Many creative business models — like Skype, ProFlowers, and eBay — have redefined the value chain by eliminating or shifting the partners that contribute to the final offering.

What is your revenue model? Factors such as how you’ll charge for the product, how much you’ll charge, and which portions of your offerings will be the biggest money makers all determine your revenue model. For instance, most airlines have radically changed their revenue models to charge for items that used to be bundled into the ticket price, effectively making them free. Items like checked bags, extra legroom, in-flight food, and even carry-on bags now generate billions of dollars in revenue for airlines.

What is your competitive strategy? You don’t want to just jump into the shark tank. You need a plan to differentiate yourself from competition — via marketing, sales, and operations — that allows you to effectively outshine the competition

How will you maintain your competitive edge? After you distance yourself from competitors, how will you hold off their attempts to copy your winning strategies? The best business models create barriers to maintain their hard-earned competitive advantage.

What partners or other complementary products should be used? Henry Ford was famous for creating companies to make everything included in his cars. Toyota relies on a partner network to engineer and manufacture most of the components for its cars. Savvy relationships with partners can enhance your business model.

What network effects can be harnessed? If you owned the only fax machine, it wouldn’t be worth much because you couldn’t send or receive a fax. Network effects enhance the value of everyone’s purchase when the network of users grows. Nightclubs and Facebook rely on their large network of users to increase the value of their offer.

The best business models aren’t merely an idea. A great business model solves problems for customers creatively and generates more profit than was previously thought possible.

Business Models in Their Simplest Form

You have an overwhelming number of factors and concerns to consider when creating a business model. It can be daunting. Don’t worry. By the end of this book, you’ll have an understanding of all the inner workings of a business model and their interrelationships.

In the meantime, here’s a simple three-part method to break down a model:

What is the offering? Are you selling roses on the side of the road or fractional use of private jets? Why do customers need your offering? How is it different from customers’ other options to solve their problem? Are you selling your product to the best market and in the best niche? Chapters 6 and 7 walk you through the basics of creating a powerful offering.

How will you monetize the offering? Twitter has a powerful offering providing hundreds of millions of users valuable communication tools. However, Twitter has struggled to turn this offering into sales. You must have more than just a product people want. You must be able to charge a price that generates significant margin and be able to sell it. Sharper Image was a company whose products were priced at a level that afforded high margins; however, not enough customers bought them. You must be able to execute your sales strategy in order to complete the monetization of the offering. Chapters 8 and 9 discuss making money with your business model.

How will you create sustainability? Blockbuster Video had an exceptionally profitable business model for nearly two decades, but the company was unable to sustain it. Factors such as maintaining/growing competitive advantage, the ability to innovate, and avoiding pitfalls affect the sustainability of the business model. See Chapters 10, 11, and 12 for an in-depth discussion of sustainability.

Examples of Business Models

There are business models hundreds of years old and those only a handful of years old, such as Internet freemium models. Some of the most profitable companies didn’t invent new business models; they borrowed a business model from another industry. The Gillette razor and blades model has been highly profitable for Hewlett-Packard’s inkjet printer business and Verizon’s cellphone business. The cheap chic business model works for Trader Joe’s in the grocery business and IKEA in the home furnishing business. Sometimes, one little tweak to an existing business model can yield powerful results in a new industry.

Table 3-1 shows a partial list of common business models. These examples should get your creative juices flowing as you begin to create your business model. Review the list for small ideas you can work into your model rather than copying a model lock, stock, and barrel.

Table 3-1 Types of Business Models

Type of Model	Description	Example Companies and Products
Razor and blades	Consumer purchases a low-margin item like a razor handle or inkjet printer. Sale of necessary consumables such as replacement blades or ink are sold at a very high markup.	Gillette, Hewlett-Packard printers, Kuerig coffee makers
Inverted razor and blades	Initial purchase has a high margin, but consumables are sold at a low margin to entice initial purchase or contrast to razor and blade competitor.	Kodak inkjet printers, Apple iPod & iTunes combination. Apple makes very low margins on iTunes but high margins on hardware.
Cheap chic	Marketing of stylish but inexpensive merchandise. Typically allows for high margins because merchandise sells at low price points but has an expensive feel.	Target, Trader Joe’s, IKEA
Bricks and clicks	Extension of in-store shopping to include online ordering with in-store pickup or items found exclusively online.	BestBuy.com, local mystery book store with online shop
Multilevel marketing	Leverage friends, family, and other personal networks to recommend products and act as a sales force. Works best for products needing recommendation to facilitate purchase.	Avon, Mary Kay, Amway
Franchise	Sell the right to use the business model in exchange for a percentage of revenues.	McDonald’s, Holiday Inn, NFL
Anticipated upsell	High percentage of buyers ultimately purchase more than they expected. For instance, most new home buyers end up spending 1.2 times the base price of the home after extras. Builders bet on this upsell.	Homebuilders, car dealerships, steel fabricators
Loss leader	This model offers velocity items for a very low margin in anticipation of additional sales at a higher margin.	Gas stations, $1 menus
Subscription model	One of the more popular models because of recurring revenue. Typically involves creating a significant asset and renting a piece of it.	Health clubs, software as a service
Collective	Similar to a franchise. Involves many businesses coming together for purchasing, marketing, or operational purposes but with looser ties than a franchise. Typically, collectives aggregate buying power and don’t pay ongoing royalties like a franchise.	Ace Hardware, CarQuest
Productization of services	Standardizing a predetermined bundle of services typically bought together and selling for a fixed price similar to a product. Many times it includes an element of flat-fee pricing as well.	A consultant charges $5,000 for a business plan analysis rather than charging $200 per hour, prepaid legal plans
Servitization of products	Making a product part of a larger service offering.	Rolls-Royce sells aircraft engines, not as distinct components but as complete solutions based on aviation miles. All operations and maintenance functions are included in this “Power by the Hour” plan.
Long tail	Based on Chris Anderson’s famed 2004 Wired magazine article. Selecting a tiny niche and serving it in ways mass marketers can’t. Hopefully, the tiny niche grows into a much larger one, as it did in the case of Fat Tire beer.	YouTube bands, left-handed online store, micro-breweries
Direct sales	Bypass the traditional sales channels to target end users. Methods include door-to-door sales and company-owned stores.	Kirby Vacuums, Girl Scout cookies, outlet mall stores
Cut out the middle man	Removal of intermediaries in a supply chain. AutoZone bypasses traditional three-step distribution by skipping the warehouse distributor.	Dell Computer, farmer’s markets
Freemium business model	Product is offered for free. Typically 8% of users upgrade to become paying customers of virtual goods or to get expanded access.	Angry Birds, shareware software, McAfee security
Online auctions	Create a community of buyers and sellers by using an auction-type selling process versus a set sales price.	eBay, Arriba
Hotel California model	Create a must-have product that traps customers into buying unrelated high-profit items like concessions at a baseball game.	Amusement parks, sporting events, movie theaters
Network effect	Create a product in which the value to each user becomes higher as more people use it.	Fax machines, social networks
Crowdsourcing	Leveraging users to co-create products and sell to other users.	Cafepress.com, Frito Lay new flavors, YouTube, Angie’s List
Users as experts	Gives users access to technology and tools typically reserved for company employees. Users then create their own designs or versions of the product.	Cook-your-own-steak restaurants, Lego
Premium	Offer high-end products that appeal to brand-conscious consumers.	Tiffany, Rolls-Royce
Nickel and dime	Price the most cost-sensitive item as low as possible and then charge for every little extra.	Airlines
Flat fee	The opposite of nickel and dime. Most or all incidental purchases are bundled into one fee.	Sandals Resorts, Southwest Airlines