Business model features
A business model explains how a company makes money: who its customers are, what it sells and why they buy, where it sells, how it prices, and how it is organized to deliver at a profit. Analysts build their own view rather than relying on management's description.
Before this: The Firm and Market Structures
On the exam
- Describe key features of business models
Describe the key features of a business model. Expect: spot the element a management description leaves out (usually the customer); value chain versus supply chain; channel terms such as direct sales and omnichannel; and what unit economics measures.
How deeply to learn each part
- Know the idea
- Understand it in general. It frames other topics, but you will not calculate with it.
- Use it
- Understand it well enough to solve a question with it. Recognize when it applies.
- Memorize
- Learn it by heart. The exam will not give it to you.
You know this one. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still do.
You tested strong here. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still know it.
What does a business model describe?
A business model is a description of how a business works. It answers five questions: who the customers are, what the firm offers and why they buy it, where and how it sells, how much it charges, and how it is organized to deliver. It should give enough detail that the basic elements and the links between them are clear, without becoming a full business plan.
Take Fernhill Coffee Co., a fictional roaster.
| Question | What to pin down | Fernhill Coffee Co. |
|---|---|---|
| Who? | target segments; business or consumer customers | office managers at mid-sized firms and home espresso fans |
| What (and why)? | the product or service, and the job the customer hires it for | bean subscriptions and leased office machines: good coffee without hassle |
| Where? | sales and delivery channels | own website and field sales for offices; supermarkets for retail packs |
| How much? | premium, parity or discount; pricing model | premium beans justified by freshness; machines priced near cost |
| How? | assets, partners, suppliers, value chain, cost structure | roasting plant owned; delivery outsourced; service technicians in-house |
Fernhill Coffee Co. · business model canvas
Value proposition
Fresh premium coffee that arrives on schedule, with machines serviced for you, at a premium price.
Who + what + where + how much: why customers choose Fernhill at its price.
Who?
Office managers at mid-sized firms (B2B) and home espresso fans (B2C).
Name the segments. This is the element a pitch most often leaves out.
What, and why?
Bean subscriptions and leased office machines. The job customers hire it for: reliable, good coffee without hassle.
The product, and the reason customers buy it.
Where?
Own website and field sales for offices; supermarkets for retail packs.
Channels: direct to offices, through intermediaries for shoppers.
How much?
Premium bean prices, justified by freshness. Machines priced near cost.
Premium, parity or discount, and the pricing model.
How?
Owns its roasting plant, outsources delivery to a courier and keeps service technicians in-house.
Assets, partners, capabilities and cost structure.
Profit, per kilo of beans
Price USD 30 − unit cost USD 18 (beans 10, roasting and packing 5, delivery 3) = margin USD 12, or 40% of price.
Do prices and volumes cover the costs, now or at scale? Check margins, breakeven and unit economics.
Value chain: Fernhill's own activities
- Inbound logisticsGreen beans in from importers
- OperationsRoasting in its own plant
- Outbound logisticsPacks orders, hands them to a courier
- Marketing and salesWebsite and field sales team
- ServiceTechnicians fix office machines
- Infrastructure finance, head office
- People roasters, technicians
- Technology subscription website
- Procurement buying green beans
Supply chain: every step to the customer, inside or outside the firm
- Farms
- Importers
- Fernhill
- Courier
- Office or home
- Who? Memorize customer segments, B2B or B2C, geography
- What (and why)? Memorize the product or service and the need it meets
- Where? Memorize channels for selling and delivering
- How much? Memorize premium, parity or discount; pricing model
- How? Memorize assets, partners, suppliers, value chain, cost structure
Many successful businesses are not new inventions. Wholesalers, retailers, law firms, banks and building contractors run conventional models, and they win through execution, skill, brand or scale. Others succeed by combining familiar pieces in a new way. Either way, the analyst’s job is the same: write down the five answers, then test whether the model works.
Who are the customers?
The analyst should identify the target customers. Are they particular types, or segmenting groups of customers by attributes such as geography, demographics, behavior, preferences, income, affinity for technology or self-image? Are they other businesses (B2B , business-to-business) or consumers (B2C , business-to-consumer)? Which regions are served?
The answers drive forecasts of units sold and prices. They also bring risks, such as high barriers to entry, a shifting customer base or tougher competition. Business customers usually have straightforward needs, are sophisticated buyers and want to earn a profit. Consumers have varied needs that can be hard to quantify, and advertising can create some of those needs.
What is sold, and why do customers buy it?
The business model should say what the product or service is and how it differs from rivals’ offers, by reference to the needs of the target customers. Asking why customers buy, the “job” they hire the product to do, shows who the real competitors are. Video-call software and business-class flights do not look alike, but both let a manager meet a distant client, so each competes with the other for some meetings.
Be careful with broad claims. Some companies describe an enormous addressable market, overstate their differentiation or mention “platforms” and “networks” that barely exist, to suggest that everyone is a customer. Check such assertions against independent research.
Where does the firm sell? Channels
A firm’s channels are how it sells (sales and marketing) and how it delivers (distribution and logistics). The analyst should separate what the firm does itself from what partners do.
- Traditional channel Use it manufacturer, wholesaler, retailer, customer
- Direct sales Memorize firm sells to the end customer; complex or high-margin products, B2B
- Omnichannel Memorize digital and physical together, such as order online and collect in store
In a traditional channel, a product passes through intermediaries, such as a wholesaler and a retailer, each of which buys and resells it. In a direct sales strategy the firm sells straight to the end customer. That is common for complex or high-margin products such as medical devices, industrial equipment and luxury goods, and for B2B models where the pool of buyers is small and easy to reach. The advantages are a close customer relationship and no rival products on the same shelf. The cost is heavy and partly fixed: salaries and benefits for a sales force, though digital selling increasingly supplements or replaces it.
Channels are often combined. An omnichannel strategy uses digital and physical channels together to complete one sale, for example ordering online and collecting in a store, or choosing in a store and having it delivered. It is common in apparel and packaged consumer goods.
Channels drive revenue, cost behavior and risk. A firm that sells direct will have a different cost structure from competitors that sell through dealers, which affects how comparable their results are.
How much does it charge?
The model should show whether the firm prices at a premium, at parity or at a discount to competitors, how prices compare with costs, and why the pricing is justified. A premium may be justified by savings elsewhere, such as a lower total cost of ownership , the total direct and indirect cost of owning an asset over its life. It may instead rest on brand and distinctiveness that customers simply value, as with most luxury goods. The next lesson covers pricing power and the different ways of billing.
What is the value proposition?
The value proposition brings the first four answers together: who, what, where and how much. It is the set of attributes customers value that makes them buy from one firm rather than another, given the price. It has four parts:
- the product or service itself: capability, performance, features and style;
- the service and support behind it, from high-touch help to repairs and spare parts;
- the sale process, such as convenient purchase and easy returns;
- the price relative to competitors.
A firm can be constrained by regulation, by customers who care only about price, or by selling a thin-margin commodity.
Go deeper Same bicycle, two business models
Kestrel Cycles, a fictional maker, builds one sturdy city bike. It can sell the bike outright to commuters through independent dealers at a premium price, or keep ownership and rent the same bike to city workers for a monthly fee through an app, with repairs included.
The product hardly changes, yet every other answer does. Who: buyers who want to own a bike versus workers who only want to get to the office. Where: dealer showrooms versus an app and street pick-up points. How much: a one-off price versus a subscription. How: a dealer network versus a fleet of bikes, repair vans and payment software. That is why business model innovation often reuses a familiar product and changes the answers around it.
How is the firm organized to deliver? Value chain and supply chain
The “how” asks what labor, capital, relationships, intellectual property and other capabilities the firm needs, and whether it must own them or can contract for them. A critical supplier can be a key part of the strategy and a risk, especially when the supplier is also a competitor.
The firm’s systems and processes that create value for its customers are its value chain . It includes only activities that one firm performs, including ones customers value that never touch the product. A firm’s value chain is different from its supply chain , the sequence of steps involved in producing and delivering a product to the end customer, whether a single firm performs them or not.
- Primary activities Memorize directly make and sell the product
- Inbound logistics receiving and storing inputs
- Operations turning inputs into the product
- Outbound logistics delivering to customers
- Marketing and sales finding and winning customers
- Service support and repairs after the sale
-
- Support activities Memorize keep the primary activities running
- Firm infrastructure finance, legal, management
- Human resource management hiring and training
- Technology development product and process know-how
- Procurement buying inputs
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To analyze a value chain: identify the activities the firm carries out, estimate the value added and cost of each, then look for competitive advantage. It links the value proposition to profitability.
Exam tip One word separates them: the value chain is the firm’s own, the supply chain is everyone’s.
Does the model make money?
A business model should show how prices and volumes will not only cover variable and fixed costs, today or at greater scale, but exceed them. The analyst looks at margins, breakeven points and unit economics , which state revenues and costs per unit, per customer or per order.
For a subscription, one useful check is how long it takes to earn back the cost of winning a customer. Each month, the customer pays a price and costs to serve, leaving a contribution of . Dividing the acquisition cost by that contribution gives the payback period in months.
A subscription sells for 12.00 a month with variable costs of 3.00 a month. Winning each customer costs 90.00. The number of months to recover the acquisition cost is closest to:
90.00 ÷ (12.00 − 3.00) = 10 months
Payback period in months, T10
- 90÷(12−3)=10
- 90ENTER12ENTER3−÷10
ENTER enter (on the HP, puts the number on the stack)
Go deeper A key supplier who is also a competitor
Suppose a meal-kit company relies on a single logistics group for chilled storage and next-day delivery, and that group then launches its own meal-kit brand. The supplier is critical, a replacement cold-chain network would take months to arrange, and the supplier could favor its own boxes when capacity is tight. That dependence is a business model risk. The analyst should look for it in the risk factors and ask how quickly the firm could switch.
Memorize this
MemorizeThe five questions
| Question | What to pin down |
|---|---|
| Who? | target segments (geography, demographics, behavior, income); B2B or B2C |
| What (and why)? | product or service, and the need the customer hires it to meet |
| Where? | channels: selling and delivering; traditional, direct sales, omnichannel |
| How much? | premium, parity or discount to rivals; the pricing model |
| How? | key assets, partners and suppliers; value chain; cost structure |
Memory hook Who, What, Where, How much, How: the customer comes first, and it is the one a management description most often skips.
Know it cold Value proposition = Who + What + Where + How much: why customers pick you at your price.
MemorizeValue chain versus supply chain
| Value chain | Supply chain | |
|---|---|---|
| Scope | the firm's own activities | every step from inputs to the end customer |
| Who performs the steps | one firm | the firm and others |
| Contents | 5 primary + 4 support activities | sourcing, making, moving, delivering |
| Shows | where the firm adds value and margin | how a physical product gets to the customer |
Memory hook Value chain = my links. Supply chain = all the links, mine or not.
Know it cold Primary: inbound logistics, operations, outbound logistics, marketing and sales, service. Support: infrastructure, people, technology, procurement.
- Who? Memorize customer segments, B2B or B2C, geography
- What (and why)? Memorize the product or service and the need it meets
- Where? Memorize channels for selling and delivering
- How much? Memorize premium, parity or discount; pricing model
- How? Memorize assets, partners, suppliers, value chain, cost structure
- Traditional channel Use it manufacturer, wholesaler, retailer, customer
- Direct sales Memorize firm sells to the end customer; complex or high-margin products, B2B
- Omnichannel Memorize digital and physical together, such as order online and collect in store
- Primary activities Memorize directly make and sell the product
- Inbound logistics receiving and storing inputs
- Operations turning inputs into the product
- Outbound logistics delivering to customers
- Marketing and sales finding and winning customers
- Service support and repairs after the sale
-
- Support activities Memorize keep the primary activities running
- Firm infrastructure finance, legal, management
- Human resource management hiring and training
- Technology development product and process know-how
- Procurement buying inputs
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Quick example
A subscription sells for 20 a month with variable costs of 8. Winning each customer costs 156. Payback = 156 ÷ (20 − 8) = 13 months.
- 156÷(20−8)= 13
- 156ENTER20ENTER8−÷ 13
ENTER enter (on the HP, puts the number on the stack)
How it is asked
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Which element is missing?
The CEO describes the product, the channel and the price. What did the CEO leave out?
The target customers (who). Product, channel and price are all named.
-
Value chain or supply chain?
'The firm's own activities that create value for its customers' describes the:
Value chain. Trap: supply chain, which includes other firms' steps.
-
Which firms sell direct?
Direct sales is most typical for which product: packaged groceries, industrial equipment or commodity metals?
Industrial equipment: complex, high-margin, few reachable customers.
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Unit economics: payback on acquisition cost
Price 15 a month, variable cost 6, acquisition cost 63. Months to recover?
63 ÷ (15 − 6) = 7 months. Trap: dividing by the price alone (4.2).
Exam traps
- Treating the value chain and the supply chain as the same thing. The value chain covers only what one firm does; the supply chain runs end to end, whoever performs each step.
- Forgetting the customer. A description that names product, channel and price but not who buys is missing the first element of a business model.
- Accepting management's description at face value. Broad claims about the market or vague talk of platforms and networks are warning signs; build your own view.
- Confusing the value proposition with the price. It covers the product, service, ease of buying and the price relative to rivals, all together.
Checkpoint
4 exam-style questions. About 90 seconds each.
1A founder tells an analyst: "We brew low-sugar sparkling teas from organic leaves, sell them through our own website and through convenience-store chains, and price them about 30% above supermarket soft drinks." Which element of the business model is missing from this description?
2A firm's value chain best describes:
3Selling directly to end customers rather than through intermediaries is most typical for:
4A language-learning app charges 15 a month. Variable costs are 6 a month per subscriber, and the firm spends 63 on advertising to win each subscriber. The number of months to recover the acquisition cost is closest to:
Key takeaways
- A business model answers who, what (and why), where, how much and how.
- The value proposition is why customers choose you at your price.
- The value chain is the firm's own activities; the supply chain is every step to the end customer.
- Check that the model turns into profit: margins, breakeven and unit economics.
- Build your own view of the model; management's description is a starting point.
Quick example
A subscription sells for 20 a month with variable costs of 8. Winning each customer costs 156. Payback = 156 ÷ (20 − 8) = 13 months.
- 156÷(20−8)= 13
- 156ENTER20ENTER8−÷ 13
ENTER enter (on the HP, puts the number on the stack)
Questions about this lesson?
Where this comes back
- Industry and Competitive Analysis Equities
- Company Analysis: Past and Present Equity Investments
- Company Analysis: Forecasting Equity Investments
- Capital Structure Corporate Finance
Questions candidates ask
What are the key elements of a business model?
Who the customers are, what the firm sells and why they buy, where and through which channels it sells, how much it charges relative to rivals, and how it is organized to deliver: assets, partners, suppliers and costs. Together they should show how the firm makes a profit.
What is the difference between a value chain and a supply chain?
A value chain covers only the activities one firm performs to create value for customers, from inbound logistics to service. A supply chain covers every step needed to produce and deliver a product to the end customer, whether the firm or other firms perform it.
What is a value proposition?
It is the set of attributes that makes customers choose one firm over rivals at its price: the product itself, service and support, the buying and returns process, and the price relative to competitors.
What is the difference between direct sales and omnichannel?
Direct sales means the firm sells straight to end customers without wholesalers or retailers, common for complex or high-margin products. Omnichannel combines digital and physical channels in one sale, such as ordering online and collecting in a store.
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