What goes into a business model?
In 1904, King Gillette, the founder of Gillette Razors, not only invented, through patents, the razor, the blade and the combination of the two but King Gillette invented a new business model. The business model, known today as the razor-blade model, has been taught in business schools and implemented in almost every industry worldwide. In this particular model, companies sell a one-time product at a substantial discount that is complemented by another higher margin product that requires repetitive purchases – DVR, DVD, Keurig, razors, etc. Thus, King Gillette built a business model that has acquired customers for over 100 years.
Peter Drucker thought, in his theory of business, the sole purpose of a business model was to create a customer. Johan Magretta describes business models as a system that fits the pieces of the business together that tell a story of how the enterprise works. In today’s competitive environment, it’s vital that businesses know and understand their particular model and how they create customers. In a 2016 PwC survey, 74% of CEOS believed there are more threats to business growth than there were three years ago. However, 69% think there are more growth opportunities today. To capitalize on these opportunities, companies need to reevaluate their model to ensure it still fits their market. If not, then the company needs to innovate because they’re likely to be disrupted by competition.
Webster-Merriam’s definition of a business model is a design for the successful operation of a business, identifying revenue sources, customer base, products, and details financing.
If you follow Clayton Christensen and Mark Johnson, you know that they define business models as “four interlocking, interdependent elements that, taken together, create and deliver value,” The four components of a business model are the customer value proposition (CVP), profit formula, key resources, and key processes.
Customer Value Proposition
Companies that can solve a client’s problem or help them accomplish a job will be successful because it’s able to add value. A CVP comprises of a target customer, product or service offering, and the problem it solves.The CVP needs to be precise, and being precise is often the most challenging to define. Without precision, the CVP will be too broad and thus, creating too much competition. A company can focus on precision by helping to address four common barriers that keep customers from finding solutions to their needs: access, skill, insufficient wealth, or time.
Four questions to ask:
1. What is the company’s target market?
2. What solution is the business able to create?
3. Does the offering bring enough value to define its precision?
4. Does the CVP address the four customer barriers?
The profit formula refers to the methodology the company uses to create value for itself while creating value for its customer. The profit formula consists of:
- Revenue model: price x volume
- Cost structure: economies of scale, direct costs, indirect costs
- Margin model: understanding desired revenue volume and cost structure, the business will be able to calculate the contribution needed to meet expected profits
- Resource velocity: how fast does fixed assets, inventory, and other assets turn over, and how well does the company utilize resources to support the margin model
Key questions to ask when determining your profit formula:
1. What is the desired revenue and desired profit?
2. Does the target market support the volume?
3. What fixed and variable cost will have the biggest impact on the company’s overall cost structure?
4. How does the company measure resource velocity?
The key resources for a company are the people, skills, products, technology, equipment, facilities, and brand. These resources are required to deliver the CVP to its target market.
When evaluating key resources, ask the following:
1. What are the company’s core competencies?
2. Does the company have the necessary technology, equipment, and facilities in place to align with the CVP?
3. How well is the brand position in the market?
Successful companies have managerial and operational procedures in place that will allow them to scale not only the enterprise but also the value delivered. These processes may include development, manufacturing, training, planning, sales, budgeting, delivery, and service.
Questions to consider:
1. What process(es) does the company do that is different from the market?
2. How does the dynamics of each process affect the relationship with one another?
3. What, if any, process is proprietary, or can be leveraged, that gives the business a competitive advantage?
A business model is simple but yet complex in its functionality due to its dependency on each element. In a synopsis, the CVP and profit formula define how the customer and company will receive value, and the key resources and key process will identify how that value will be delivered. In order to determine if the company’s business model is working or not, the enterprise will need to be patient and have an ongoing evaluation of the P&L.
1. Magretta, Johan. “Why Business Models Matter” Harvard Business Review 80, no. 5 (May 2002): 86-92
2. PwC “2016 US CEO Survey: Top Findings,” n.d., www.pwc.com.
3. Christensen, Clayton M., and Mark W. Johnson. “What Are Business Models, and How Are They Built?” Harvard Business School Module Note 610-019, (August 2009).
4. Christensen, Clayton M., Johnson, Mark W., and Kagermann, Henning. “Reinventing Your Business Model.” Harvard Business Review 86, no. 12 (Dec 2008): n/a.