business models

The basic outline of a business model is an outline of a company’s plan to make money from the product or service it offers to its customers.

Every business plan contains four basic parts:

  • The product or service they plan to sell
  • The company intends to use that product or service to sell
  • Costs the company faces in creating and selling its products or services
  • How do they expect to earn profits

Business models are constantly changing and different companies in the market offer different types of products or services.

As investors, we need to understand those fundamentals and how they affect the company’s prospects and its plans to get there. For example, in the payments space, many companies offer the ability to facilitate payments, but some companies focus on smaller niches. Companies like Fleetcor and Wex offer truckers the ability to pay with a corporate card, allowing the corporation to manage their driver usage, track their routes and manage those expenses.

Through the use of business models, investors and businesses can pinpoint their target market or TAM (total addressable market), which enables both parties to assess the viability of the good or service.

Established businesses must update their business model regularly or they will fail to anticipate upcoming trends and challenges. Business models also help investors evaluate companies they are interested in and employees understand the future of a company they may aspire to join.

  • A business model is a company’s basic strategy for doing business profitably.
  • Models typically include information such as the products or services the business plans to sell, the target market, and any expected costs.
  • There are dozens of business models, including retailers, manufacturers, fee-for-service, or freemium providers.
  • The two levers of a business model are pricing and cost.
  • When evaluating a business model as an investor, consider whether the product offering fits the real need of the market.
business models

Understanding business models

A business model is a high-level plan for operating a business profitably in a specific market. A fundamental part of the business model is the value proposition. This is a description of the goods or services a company offers and why they appeal to customers or clients, ideally in a way that differentiates the product or service from its competitors.

A business model for a new entrepreneur should also cover projected start-up costs and sources of financing, 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 for the business to partner with other established companies. For example, the business model for an advertising campaign may identify benefits from a printing company and an arrangement for referrals.

Successful businesses have business models that allow them to meet client needs at competitive prices and sustainable costs. Over time, many businesses periodically revise their business models to reflect changing business environments and market demands.

When evaluating a company as a possible investment, the investor must find out how it will make money. This means looking at the company’s business model. Admittedly, the business model doesn’t tell you everything about a company’s prospects. But the investor who understands the business model can get a better understanding of the financial data.

assessing effective business concepts

Underestimating the cost of capital until the business becomes successful is a common error many businesses make when developing their business plans. It is insufficient to just estimate the price of introducing a product. A business must continue operating until its revenues outweigh its costs.

The company’s gross profit can be used as one indicator for analysts and investors to determine whether a business strategy is successful. A company’s gross profit is its entire revenue less its cost of products sold (COGS). The gross profit of a company provides insight into how efficient and effective its business strategy is in comparison to that of its primary rival or its sector. Gross profit, nevertheless, is not always reliable. Analysts want to see net income or cash flow. It represents gross profit less operating expenses and provides insight into the true profitability of the company.

business models

Pricing and cost are the two main axes of a company’s business plan. A business may decide to boost pricing while locating inventory at a discount. Gross profit is raised by both actions. When assessing a business plan, the majority of experts place a higher priority on gross profit. A strong gross profit hints at a strong business strategy. The management team may be in error and make the necessary corrections if costs are out of control. This shows that a lot of analysts think businesses using the best business strategies can survive independently.

The 12 most common types of business models

The list below is not exhaustive and there are as many business models as there are stars in the sky. But this list remains its most common type.

1. Model of subscription

The subscription business model is applicable to both offline and internet enterprises. The model’s fundamental tenet is that customers make recurring purchases. payment for access to the company’s goods or services, either monthly or annually.

The business has several delivery options, including mail, apps, and space access. A few examples are YouTube TV, Netflix, Disney+, Hulu, StickFix, Duolingo, Audible, Planet Fitness, and Disney+.

2. Freemium design

With the rise of SaaS enterprises and the Covid epidemic, the freemium model boomed (Software-as-a-Service).

The fundamental SaaS model operates as follows: a software provider supplies a proprietary tool that is hosted on its platform and is freely accessible by users through an app or website. However, in order to generate interest, the corporation limits the use of some important features to which regular users would eventually need more access. This will persuade consumers to subscribe in order to gain access to those functions.

3. Bundling model

The bundling model involves companies offering two or more products or services together, often at a lower price than they would charge individually.

The bundling model allows companies to generate more revenue while selling products that are difficult to sell individually. A disadvantage of this type of model is that margins tend to shrink as the company offers discounts to move goods. Examples include Verizon, AT&T, Adobe, and the fast food restaurant universe that offers compact meals such as Chick-fil-A, McDonald’s, and Taco Bell.

business models

4. Franchise model

The franchise model is probably the most familiar business model out there. Most of us visit the franchise daily or weekly.

In short, franchises consist of an established business plan that investors can buy, reproduce, rinse and repeat across a geographic area.

The franchisor (seller) often assists the franchisee (buyer) in the financing, marketing, planning, and operations to ensure the franchise is acquired. In return for support and access to the model, the franchisee pays the franchisor a fee, usually a predetermined percentage of profits.

Examples include Starbucks, McDonald’s, Taco Bell, Domino, Subway, UPS, and Chick-fil-a.

5. designer model

The manufacturing model, in which a manufacturer transforms raw materials into goods, continues to be the original business model.

Manufacturers today include businesses like Dell or HP that put together computers from components made by other companies, as opposed to the industrial concentration of the past. Steel and aluminum are produced from raw materials by industry veterans like US Steel, A&P, and Nucor before being shipped to others for use in the production of other products.

Intel, Stanley, Black & Decker, Dell, HP, Weyerhauser, and Nucor are a few examples.

6. delivery strategy

Distributors that bring manufactured goods to market for sale make up the distribution model.

For instance, Hershey’s produces and packages its delectable chocolate, but it contracts with independent representatives to handle product distribution and sell to shops. Distributors must buy in bulk and sell to retailers at a higher price in order to turn a profit.

The food and alcohol industries are particularly prevalent in the distribution model.

Examples include Southern Glazer’s Wine & Spirits, Fastenal, US Foods, HD Supply, WWGrainger, and Reyes Beverage Group.

7. Razor blade model

Yes, I know, strange name for a business model, but let me explain. To better understand this model, take a stroll through Walmart and note that replacement blades cost more than actual razors.

Companies in the razor industry realize that in the future they will buy more expensive blades and offer cheaper razors. Thus, the name “razor blade model”.

Companies also use the reverse razor blade model to offer a high-margin product and promote cheaper or lower-margin products as an accessory.

The classic example of the razor blade model remains the Apple iPhone. Apple sells you a high-margin iPhone and then pushes additional products and services that integrate with the iPhone.

Examples include Apple, Xbox, Keurig, Gillette and Brita.

8. Retailer model

The retailer continues to be the last link in the supply chain. These businesses buy goods or services from distributors for resale. They must sell enough of these goods or services to cover costs and make a profit.

Retailers often focus on a specific niche, for example, sports memorabilia, clothing, shoes, kitchenware or books.

Examples of this popular business model include Home Depot, Walmart, Amazon, Target, Best Buy and Restoration Hardware.

9. Product to service model

The manufacturing-to-service model follows that instead of creating the parts for a product yourself, you outsource the idea to someone else who specializes in creating that particular part.

Companies that follow the model allow customers to buy the result instead of the equipment to provide the result. For example, instead of buying a car to go to the movies, you buy a ride from Uber.

Examples include Uber, Lyft, Zipcar, Delta, United, and Southwest.

10. Model for leasing

With the leasing model, businesses can buy things and then rent them out to customers on a regular basis. The high-priced industries like manufacturing or medical devices are where the leasing model performs best.

U-haul, Enterprise, Avis, and Rent-A-Center are a few examples.

11. Crowdsourcing technique

By using the crowdsourcing concept, businesses may access a far wider talent pool without having to hire staff. Utilizing the internet and social media, it entails leveraging other people’s ideas, information, or works.

For instance, Waze, a navigation app, encourages users to report various road conditions so that other users can benefit from real-time assistance.

Wikipedia, YouTube, Waze, and IMDB are a few examples.

12. The one-to-one system

The final business model in the series, the one-for-one model, entails a corporation giving one item to a charity for each one that a customer purchases.

In order to persuade customers to make more purchases, the model makes use of both the public’s tendency toward altruism and their sense of social responsibility. Additionally, it enables consumers to benefit from the purchase of goods or services they require or want.

TOMS, Warby Parker, and Smile Squared are a few examples.

business models

Investor takeover

To better understand a potential investment, we need to understand how a company makes money. Ideas can range from products and services offered to target markets, cost and business model viability.

Business model failure list spans news from BlackBerry to Sears; Many companies failed because they did not adapt their business models or failed to anticipate possible changes.

The airline industry offers a great cautionary tale for finding business models that no longer make sense.

Joanne Magretta, former editor of the Harvard Business Review, suggests two key factors to quantifying business models as a big deal. When a business model stops making sense, it falls into a story that no longer makes sense, and the numbers don’t add up to profits.

As investors learning how to analyze businesses, we need to understand the business model and how they make money. The list of business models above and the four-part quiz are a great starting point. With that, we will finish discussing the list of business models.

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2 thoughts on “What are business models? About the 12 most common types of business models.”
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