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You have an idea. Maybe you’ve invented a new product, or you have a unique service that you believe could help potential customers in a new and different way. You want to take this idea and turn it into a business.
Along the way, someone has probably told you that you need a business model. And so, here you are. Likely thinking, “Just what exactly is a business model, anyway?” “Is that the same thing as a business plan?” “How important is business model generation to this whole starting a business process, really?”
All very reasonable questions, my friend. After all, even management experts haven’t come to a true consensus on what a business model is exactly. It seems the scope and definition of the business model can be as varied as the businesses themselves.
Famed management writer Joan Magretta defined the business model as “the story that explains how an enterprise works.”
Other business analysts, in search of a definition, throw back to business writer Peter Drucker’s age-old questions: “Who is your customer?” and “What does your customer value?” “Then, how do you deliver value at an appropriate cost?”
Before you start down the rabbit hole of business model generation, do yourself a favor. Stop. Take a deep breath. And stop thinking about business models at all. Get all the big, technical, fancy business words out of your head, and just focus on the basics.
Why do you want to launch this business, anyway? Who are you trying to help?
As Magretta describes, imagine yourself telling the story of your business. Develop the character that is your customer. What is the plot of your customer’s story? What does your customer need to achieve? How can he or she make that happen? And how does your business fit into your customer’s story?
Before you dress your business model up into its technical, official form, this is all it is, in essence: a story.
Of course, there are as many ways to go about business model generation as there are businesses in the world. Just as there is no one accurate definition, there is also no one accurate process. That would be too simple.
As in most aspects of entrepreneurship, there is no standard formula to follow. The process requires constant innovation, constant redefinition.
The closest we have to an accepted formula for business model generation comes from Harvard Business School’s Clay Christensen, who proposes a straightforward method consisting of four elements: a customer value proposition, a profit formula, key resources, and key processes.
Working from Christensen’s four elements, consider the following comprehensive six step process for business model generation:
What does your offering do for your customer? How does it solve your customer’s problem in a different way than other similar offerings on the market? Answering these questions will help you define your unique customer value proposition.
In order to determine how your company will do business and make a profit from your customer, you first must understand why your customer would want your offering, and what value you provide through your product or service.
Think of your profit formula like a treasure map. It describes the terrain and gives specific instructions for how your business will make money.
According to Christensen, your profit formula should include four components:
Revenue Model: Determined by factoring the price of your offering by the volume you’ll be able to produce and distribute.
Cost Structure: This includes a detailed analysis of direct and indirect costs—most specifically the costs of your key resources, which we’ll discuss in the next business model generation step below.
Margin Model: Given your expected costs and volume, what price will you need to charge to achieve the desired profit margin? Is that price reasonable given your customer value proposition?
Resource Velocity: How quickly and efficiently will you need to produce and distribute your offering in order to maintain your desired volume and profit margin?
What assets will you need in order to deliver your defined value proposition to your customer? These might include people (employees and their time, skills, and talents), technology, products, facilities, equipment, intellectual property, or virtually any other resource.
To keep your list from becoming overwhelming, focus only on those most essential assets which differentiate your business competitively from others in your market.
Next, how will your resources interact with one another to achieve your defined customer value proposition? How will you repeat this process to deliver a reliable offering at a consistent margin of profit?
Consider in detail what specific training, craftsmanship, manufacturing, distribution, or service processes you will need to implement in order to serve client needs in a regulated and dependable way.
The business model generation process is more than just a leap to hurdle in the process of launching a new business. It is a continuous, ever-evolving journey that will continue throughout the life of your business.
Once you’ve defined your customer value proposition, profit formula, key resources, and key processes, it’s important to consistently evaluate those definitions and innovate your business model.
In fact, business model innovation is so important, the IBM Institute for Business Value’s Global CEO Study reported in 2009 that an incredible 98% of businesses were in the process of modifying their business model to some extent.
Throughout the life of your business, regularly reconsider the basics model. What is working? What isn’t working? What has changed about your customer, your product, or your industry? And how can your company engage in relevant business model innovation to adapt to those changes?
In evaluating your business model, don’t forget to consider how your competitors’ choices and strategies will impact your business.
As Joan Ricart notes in a 2011 edition of the Harvard Business Review, almost any company can succeed with business model generation if it has the good fortune of being the only business in its given market! For the grand majority, competitor analysis may be the essential step which defines the success of a business model.
“Appraising models in a stand-alone fashion leads to faulty assessments of their strengths and weaknesses and bad decision-making. This is a big reason why so many new business models fail.”
Simply put, your business model is a series of choices. While Christensen’s definition offers a straightforward and effective formula for business model generation, it is by no means the only available process. In fact, your most radical and potentially most profitable result very well might require you to break the mold of business model generation completely.
Ultimately, any means you use to determine and explain how your business will serve its customer and generate revenue has the potential to result in a winning proposition.