What Is a Business Model, and How Do You Pick the Right One for You?

Meredith Wood

Meredith Wood

Editor-in-Chief at Fundera
Meredith is Editor-in-Chief at Fundera. Specializing in financial advice for small business owners, Meredith is a current and past contributor to Yahoo!, Amex OPEN Forum, Fox Business, SCORE, AllBusiness and more.
Meredith Wood

A business model is an outline of how a company plans to make money with its product and customer base in a specific market. At its core, it explains what product or service a company will sell, how it intends to market that product or service, what kind of expenses it will face, and how it expects to turn a profit.

Because there are so many types of businesses out there, business models are constantly changing; there is no one-size-fits-all model that can be applied to every business. For this reason, it’s imperative to understand how your business makes money — and enough of it to remain profitable after costs are factored into the equation.

To learn more about the different types of business models and how you can apply them to your own business, jump down to our infographic, or keep reading to learn more about the components of a business model.

Essential Components of a Business Model

Although business models may vary in their form and function, they all consist of the same basic ingredients. Essential elements of a business model include a unique value proposition, a viable target market, and a competitive advantage. Without them, you don’t have a way of generating revenue.

However, business models are not just about income. You also need to consider production costs and other factors in order to see the full picture. So, what all goes into creating a business model? Here are the 10 components you need to think about:

  1. Value proposition: A feature that makes your product attractive to your customers.
  2. Target market: A specific group of consumers who would be interested in your product.
  3. Competitive advantage: A unique feature of your product or service that can’t easily be copied by competitors.
  4. Cost structure: A list of the fixed and variable expenses your business requires to function, and how they affect pricing.
  5. Key metrics: The ways your company measures success.
  6. Resources: The physical, financial, and intellectual assets of your company.
  7. Problem and solution: Your target customers’ pain points, and how your company intends to meet them.
  8. Revenue model: A framework that identifies viable income sources to pursue.
  9. Revenue streams: The multiple ways your company can generate income.
  10. Profit margin: The amount your revenue exceeds your business costs.

These are the essentials of a business model, and they are likely to change as your business matures. From the outset, you may not have a clear idea of what each of these components will look like for your business. Ultimately, they will provide a vision and direction for your idea.

6 Most Common Types of Business Models

While there are many innovative types of business models out there, the majority of them adopt characteristics from more traditional or established archetypes.

Here are six of the most common business models:

1. Manufacturer Model

One of the most traditional business models, a manufacturer model occurs when a manufacturer converts raw materials into a product. Companies like Dell Computers or Hewlett-Packard, both of which assemble computers with parts manufactured by other companies, would still be considered manufacturers.

2. Distribution Model

A company operating as a distributor is responsible for taking manufactured goods to the market. Hershey’s, for example, manufactures and packages their chocolate, but a distributor is the agent that transfers and sells the goods from the factory to a retailer. To make a profit, distributors buy the product in bulk and sell it to retailers at a higher price.

3. Retailer Model

A retailer is the last link in the supply chain. They purchase goods from distributors, and then sell it to customers for a price that will both cover expenses and turn a profit. Retailers may specialize in a particular niche, such as kitchenware, or carry a range of products.

4. Franchise Model

A franchise is an established business blueprint that is simply purchased and reproduced by the buyer, the franchisee. The franchiser, or original owner, works with the franchisee to help them with financing, marketing, and other business operations to ensure the business functions as it should. In return, the franchisee pays the franchiser a percentage of the profits.

5. Freemium Model

The freemium business model has gained popularity with the prevalence of online and Software-as-a-Service (SaaS) businesses. The basic framework goes like this: a software company hosts and provides a proprietary tool for their users to freely access, such as an app or tool suite. However, the company withholds or limits the use of certain key features that, over time, their users will likely want to use more regularly. To gain access to those key features, users must pay for a subscription.

6. Subscription Model

A subscription business model can be applied to both traditional brick-and-mortar businesses and online businesses alike. Essentially, the customer pays a recurring payment on a monthly basis for access to a service or product. A company may directly ship you their product in the mail, or you may pay a fee to use an app.

Real World Examples of Business Models in Action

To better understand how these business models work, it helps to take a look at relevant products and services we all use on a daily basis. Here are a few examples of some modern companies and how they apply these business models:

Intel: Manufacturer

Intel is a long-standing computer manufacturing company. They fabricate their own computer chips with silicon wafers and other key computer components, like CPUs and Processors, in the U.S., China, Ireland, and Israel. Their products can be purchased online and in big-box stores, such as Best Buy.

Cheney Brothers: Distributor

Cheney Brothers is a leading food distributor that supplies the Southeastern United States and other locations with items like poultry, pork, fresh and frozen seafood, produce, and even beverages, among others. As for their infrastructure, they currently own and operate three distribution centers in the U.S. and ship bulk orders to other customers.

Home Depot: Retailer

Home Depot is one of the most well-known specialty retailers in the U.S, carrying a wide range of home improvement supplies from a plethora of companies. They are a great example of a retailing company that provides the means to sell manufactured products to the masses.

Subway: Franchise

Subway is a classic example of a franchise: each location looks and operates the same with a different franchise owner. They have an established system in place to ensure employees at every location are trained the same way — to quickly and satisfactorily serve their customers.

Spotify: Freemium

Spotify is a great example of the freemium business model. They give their users free and open access to their entire database of music while sprinkling in ads between songs. At some point, many users opt to pay a monthly fee for the premium service so they can stream music without interruption.

NatureBox: Subscription

NatureBox ships healthy snacks in boxes to their customers’ doorsteps for a monthly fee. Over the years, they’ve accrued a large inventory of healthy, nutrient-rich food alternatives that meet the requirements of just about any diet. When you order through NatureBox, you have the added benefit of adjusting your box each month so that it better accommodates you.

How to Choose the Right Business Model for You

So, how do you choose the right business model for you? Again, there is no absolute answer. It depends entirely on the scope of your operations and the costs you may incur along the way, but you can start by determining what type of business you want to run.

For example, if you want to run a manufacturing business, then you should research business models of successful manufacturers. From there, you can ask yourself the following questions to gain a better understanding of how to structure your business model:

  • How will my product or service benefit the customer?
  • How will I generate revenue?
  • Who’s my target customer?
  • What startup costs am I looking at?
  • Which expenses will be fixed and variable costs?
  • Do I need support from investors?

With the answers to these questions, you can start to formulate a better idea of what you will need to get started. Reference the components mentioned earlier and start filling in the blanks.

You may feel overwhelmed when mapping out your business model, and that’s to be expected. If this happens, just remember that a business model is simply a plan that shows how you will make money. Thinking in this way will simplify the process.

Sources: FourWeekMBA | Investopedia | Entrepreneur

 

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.
Meredith Wood

Meredith Wood

Editor-in-Chief at Fundera
Meredith is Editor-in-Chief at Fundera. Specializing in financial advice for small business owners, Meredith is a current and past contributor to Yahoo!, Amex OPEN Forum, Fox Business, SCORE, AllBusiness and more.
Meredith Wood

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