Understanding Business Model Fundamentals

This post attempts to answer the following 3 basic questions on business models: What is a business model? Why do we need to study business models? How to describe a business model? Business model is a term that is very loosely used in our day-to-day conversations. Business managers often use this term, without a complete understanding of it. When they use the term business model, they are either referring to the revenue model or the operating model. But, business model is much more than that. Before we start discussing business models, let us discuss what a model is and why do we build models. A model is a simplified version of something. It is the scaled representation of a real object. The real object can be much larger or smaller than the model representation. Models are often discussed in the field of architecture, where we build models for buildings and other physical structures. Models not only help in the process of planning and construction of new structures, but also in the understanding the design of existing structures. Models are also used in the field of engineering to showcase the design of physical products such as automobiles, aircrafts, rockets, railways, and ships. The goal is simple: Increase our understanding of the real world objects while eliminating the unimportant details. While physical models resemble the real world objects they represent, there exist schematic models and mathematical models that are more abstract than a physical model. Schematic models provide a pictorial representation of conceptual relationships. Diagrams, Charts, and Blueprints are examples of a schematic model. They help us avoid costly mistakes. They also help us in asking “what if” questions. A business model is a kind of schematic model that helps us gain the complete picture of an organization business from a high-level perspective. A business model is a framework that helps us understand how different entities of a business come together to create value for customers. These entities may include Marketing, Sales, Engineering, Manufacturing, Production, HR, Finance, IT, Administration, Partners, and Suppliers. A good understanding of business models can help managers in these different entities with the following:

  1. Quickly gain the big picture of the business. Understand how different pieces fit together.
  2. Develop the business models vocabulary. Learn to speak the language of business models.
  3. Develop a shared understanding. Conduct high-quality discussions and meetings among inter-disciplinary teams.
  4. Think beyond product/service innovation. Consider innovation in different facets of business.
  5. Bring structure to the innovation thought process.

In Architecture, any physical structure consists of several building blocks that need to be assembled to build the structure. For example, a building has stairs, elevators, electricity system, water system etc. Similarly, a business model has several components that need to be defined to understand a business. Several scholars have attempted to define the basic components and have built different frameworks using those components. The following papers discuss the attempt of those scholars:

Dr. Alexander Osterwalder – A Thought Leader in the field of Business Models Innovation – has authored a book titled, ‘Business Model Generation – A Handbook for Visionaries, Game Changers, and Challengers’.  As per Dr. Osterwalder, a Business model is defined as follows: “A Business Model describes the rationale of how an organization creates, delivers, and captures value.” As per Dr. Osterwalder, a business model can be described through 9 basic building blocks. These are listed as follows:

  1. Customer segments: Who are the group of customers?
  2. Value proposition: What is the offer for each customer segment?
  3. Channels: How to reach each of the customer segments?
  4. Customer Relationships: How to relate with customers over time?
  5. Revenue streams: How to earn revenues?
  6. Key resources: What assets are required to run the business?
  7. Key activities: What are the important activities/processes?
  8. Partner network: Who are the key partners and suppliers?
  9. Cost structure: What are the important costs?

These 9 basic building blocks can be shown visually using a diagram called ‘Business Model Canvas’. Please watch the video below explaining the business model canvas. A good understanding of business model canvas is essential before the understanding of business models of different companies. This is because it visually demonstrates the inter-linkages between different elements of a business model. The canvas is very practical and easy-to-use. The canvas helps in generating new ideas by asking few key questions. Please visit the following link to download the business model canvas and learn those key questions. http://www.slideshare.net/Alex.Osterwalder/business-model-canvas-poster

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