Business Models BA 560 Prof. Thomas Dowling Fall Term, 2005

An effective business model is the heart of a successful business plan.

Definition A business model describes, as a system, how the pieces of a business fit together. A business model’s great strength as a planning tool is that it focuses attention on how all the elements of the system fit into a working whole.

Business Model Basics Answers 2 basic questions: 1. What will a business do to be successful? 2. How will it make $$$ doing these things? A business model explains the underlying economic logic about how a business can deliver value to customers at an appropriate cost.

Business Hypothesis Business modeling is the managerial equivalent of the scientific method - you begin with a hypothesis, which the venture team tests in action and revises as necessary.

Critical Tests There are two critical tests: 1. The Narrative Test (Does the story make sense?) 2. The Numbers Test (Does the P&L add up?) Most new businesses fail because they do not pass one or both of these critical tests.

Successful Business Model Characteristics Clearly answers Peter Drucker’s question: “Who is the customer?” Has all the elements of a good story: precisely delineated characters, plausible motivations, and a plot that turns on an insight about value. Represents a better way than existing alternatives

Successful Business Model Characteristics Creates new incremental demand (not just shifting revenues between existing market participants) Generates profit. Profits tell you the degree to which your business model is working (not just sales and revenue - think dot.com here)

Role of Strategy Business models do not really consider the role of competition - dealing with competitors is strategy’s job. A competitive strategy explains how you will do better than your rivals. Many managers confuse business models with strategy.

Role of Strategy Wal-Mart’s business model - discount retailing - started in the early 1950’s. Sam Walton created a unique strategy - he sought out isolated rural towns rather than metropolitan areas and cities like the top 10 discounters when he started (1962).

Role of Strategy Sam Walton said: “Our key strategy was to put good-sized stores into little one-horse towns which everyone else was ignoring.” He rightly bet that if his stores could match or beat the city discounter prices “people would shop at home.” He was right!!!

Role of Strategy Michael Dell was a true business model pioneer. Dell’s direct to customer business model laid out which value chain activities Dell would do (and not do). Yet it still had critical strategic choices to make about which customers to serve and what kinds of products and services to offer.

Role of Strategy When a new business model changes the economics of an industry (i.e. Dell, SW Airlines) and it is difficult to replicate, it can create a strong competitive advantage.

Impact on Organizational Culture Effective business models: Align employees to deliver the kind of value the company wants to create. Are easy to grasp and remember top to bottom - easily retold to customers. Help individuals to see their own job within the larger context of the firm and to tailor their behavior accordingly. Create a powerful tool for business strategy execution.

Final Thoughts... The business model is the 'engine' of the new venture and is the most important piece of IP that any start-up actually owns. If you get the business model right, then the harder you work, the more money you make (Google is an example here). If you get it wrong, then the harder you work, the more money you lose.

Final Thoughts... The key to the business model is to: "Suivez L'argent"-- follow the money: how a business actually acquires money and uses it. When you follow the money, presumably, if there isn't any (or enough), you'll discover this early and stop.

Examples of Business Models The subscription business model The razor and blades business model (bait and hook) The multi-level marketing business model The network effects business model The monopolistic business model The cutting out the middleman model

Examples of Business Models The auction business model The online auction business model The bricks and clicks business model The loyalty business models The industrialization of services business model The servitization of products business model