Business model features

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

Business modelhow the company makes money

• 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.

Channel strategyhow the product is sold and delivered

• 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.

Value chainonly the activities one firm performs

• 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

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 $P$ and costs $c$ to serve, leaving a contribution of $P - c$. Dividing the acquisition cost $K$ by that contribution gives the payback period $T$ in months.

$$T = \frac{K}{P - c}$$

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.