What Is a Business Model?

The term business model refers to a company's plan for making a profit. It identifies the
products or services the business plans to sell, its identified target market, and any
anticipated expenses. Business models are important for both new and established
businesses. They help new, developing companies attract investment, recruit talent, and
motivate management and staff.

BUSINESS MODEL KEY TAKEAWAYS

 A business model is a company's core strategy for profitably doing business.

 Models generally include information like products or services the business plans to
sell, target markets, and any anticipated expenses.
 There are dozens of types of business models including retailers, manufacturers, fee-
for-service, or freemium providers.
 The two levers of a business model are pricing and costs.
 When evaluating a business model as an investor, consider whether the product being
offered matches a true need in the market.

Understanding Business Models

A business model is a high-level plan for profitably operating a business in a specific

marketplace. A primary component of the business model is the value proposition. This is a
description of the goods or services that a company offers and why they are desirable to
customers or clients, ideally stated in a way that differentiates the product or service from its
competitors.

A new enterprise's business model should also cover projected startup costs and financing
sources, the target customer base for the business, marketing strategy, a review of the
competition, and projections of revenues and expenses. The plan may also define
opportunities in which the business can partner with other established companies. For
example, the business model for an advertising business may identify benefits from an
arrangement for referrals to and from a printing company.

Types of Business Models

There are as many types of business models as there are types of business. For instance,
direct sales, franchising, advertising-based, and brick-and-mortar stores (Brick-and-mortar is a
colloquial term that refers to retail stores and offices that customers can visit in person, in
comparison to online stores) are all examples of traditional business models. There are hybrid
models as well, such as businesses that combine internet retail with brick-and-mortar stores or
with sporting organizations like the NBA.

Below are some common types of business models; note that the examples given may fall into
multiple categories.

 Retailer
One of the more common business models most people interact with regularly is
the retailer model. A retailer is the last entity along a supply chain. They often buy finished
goods from manufacturers or distributors and interface directly with customers.

Example: Costco Wholesale

 Manufacturer

A manufacturer is responsible for sourcing raw materials and producing finished products by
leveraging internal labor, machinery, and equipment. A manufacturer may make custom goods
or highly replicated, mass produced products. A manufacturer can also sell goods to
distributors, retailers, or directly to customers.

Example: Ford Motor Company

 Fee-for-Service

Instead of selling products, fee-for-service business models are centered around labor and
providing services. A fee-for-service business model may charge by an hourly rate or a fixed
cost for a specific agreement. Fee-for-service companies are often specialized, offering insight
that may not be common knowledge or may require specific training.

Example: DLA Piper LLP

 Subscription

Subscription-based business models strive to attract clients in the hopes of luring them into
long-time, loyal patrons. This is done by offering a product that requires ongoing payment,
usually in return for a fixed duration of benefit. Though largely offered by digital companies for
access to software, subscription business models are also popular for physical goods such as
monthly reoccurring agriculture/produce subscription box deliveries.

Example: Spotify

 Freemium

Freemium business models attract customers by introducing them to basic, limited-scope

products. Then, with the client using their service, the company attempts to convert them to a
more premium, advance product that requires payment. Although a customer may theoretically
stay on freemium forever, a company tries to show the benefit of what becoming an upgraded
member can hold.

Example: LinkedIn/LinkedIn Premium

Some companies can reside within multiple business model types at the same time for the
same product. For example, Spotify (a subscription-based model) also offers a free version
and a premium version.

 Bundling
If a company is concerned about the cost of attracting a single customer, it may attempt to
bundle products to sell multiple goods to a single client. Bundling capitalizes on existing
customers by attempting to sell them different products. This can be incentivized by offering
pricing discounts for buying multiple products.

Example: AT&T

 Marketplace

Marketplaces are somewhat straight-forward: in exchange for hosting a platform for business
to be conducted, the marketplace receives compensation. Although transactions could occur
without a marketplace, this business model attempts to make transacting easier, safer, and
faster.

Example: eBay

 Affiliate

Affiliate business models are based on marketing and the broad reach of a specific entity or
person's platform. Companies pay an entity to promote a good, and that entity often receives
compensation in exchange for their promotion. That compensation may be a fixed payment, a
percentage of sales derived from their promotion, or both.

Example: social media influencers such as Lele Pons, Zach King, or Chiara Ferragni.

 Razor Blade

Aptly named after the product that invented the model, this business model aims to sell a
durable product below cost to then generate high-margin sales of a disposable component of
that product. Also referred to as the "razor and blade model", razor blade companies may give
away expensive blade handles with the premise that consumers need to continually buy razor
blades in the long run.

Example: HP (printers and ink)

"Tying" is an illegal razor blade model strategy that requires the purchase of an unrelated good
prior to being able to buy a different (and often required) good. For example, imagine Gillette
released a line of lotion and required all customers to buy three bottles before they were
allowed to purchase disposable razor blades.

 Reverse Razor Blade

Instead of relying on high-margin companion products, a reverse razor blade business model
tries to sell a high-margin product upfront. Then, to use the product, low or free companion
products are provided. This model aims to promote that upfront sale, as further use of the
product is not highly profitable.

Example: Apple (iPhones + applications)

  Franchise

The franchise business model leverages existing business plans to expand and reproduce a
company at a different location. Often food, hardware, or fitness companies, franchisers work
with incoming franchisees to finance the business, promote the new location, and oversee
operations. In return, the franchisor receives a percentage of earnings from the franchisee.

Example: Domino's Pizza

 Pay-As-You-Go

Instead of charging a fixed fee, some companies may implement a pay-as-you-go business
model where the amount charged depends on how much of the product or service was used.
The company may charge a fixed fee for offering the service in addition to an amount that
changes each month based on what was consumed.

Example: Utility companies

 Brokerage

A brokerage business model connects buyers and sellers without directly selling a good
themselves. Brokerage companies often receive a percentage of the amount paid when a deal
is finalized. Most common in real estate, brokers are also prominent in
construction/development or freight.

Example: ReMax

How to Create a Business Model

There is no "one size fits all" when making a business model. Different professionals may
suggest taking different steps when creating a business and planning your business model.
Here are some broad steps one can take to create their plan:

1. Identify your audience. Most business model plans will start with either defining the
problem or identifying your audience and target market. A strong business model will
understand who you are trying to target so you can craft your product, messaging, and
approach to connecting with that audience.
2. Define the problem. In addition to understanding your audience, you must know what
problem you are trying to solve. A hardware company sells products for home repairs. A
restaurant feeds the community. Without a problem or a need, your business may
struggle to find its footing if there isn't a demand for your services or products.
3. Understand your offerings. With your audience and problem in mind, consider what
you are able to offer. What products are you interested in selling, and how does your
expertise match that product? In this stage of the business model, the product is
tweaked to adapt to what the market needs and what you're able to provide.
4. Document your needs. With your product selected, consider the hurdles your
company will face. This includes product-specific challenges as well as operational
difficulties. Make sure to document each of these needs to assess whether you are
ready to launch in the future.
5. Find key partners. Most businesses will leverage other partners in driving company
success. For example, a wedding planner may forge relationships with venues,
caterers, florists, and tailors to enhance their offering. For manufacturers, consider who
will provide your materials and how critical your relationship with that provider will be.
6. Set monetization solutions. Until now, we haven't talked about how your company will
make money. A business model isn't complete until it identifies how it will make money.
This includes selecting the strategy or strategies above in determining your business
model type. This might have been a type you had in mind but after reviewing your
clients needs, a different type might now make more sense.
7. Test your model. When your full plan is in place, perform test surveys or soft launches.
Ask how people would feel paying your prices for your services. Offer discounts to new
customers in exchange for reviews and feedback. You can always adjust your business
model, but you should always consider leveraging direct feedback from the market
when doing so.