Not really sure what a business model is? You're in the right place. Understanding business models—and their contents—will give you a universal key to understanding the value organizations create and how they deliver that value.
If you're familiar with business models, you might find it helpful to go to our Digital Value Models guide or scan this section to see how business models are evolving for the digital age.
A business model describes the key components that make up an organization and how it creates value in the world.
A business model can apply at various altitudes—an entire organization, a holding company, a line of business, or even a specific team.
Business models help determine the elements necessary to turn a good idea into a functioning business or organization and are sometimes used to evaluate a business from the following perspectives:
There are two types of business model innovation: incremental and exponential.
Incremental innovation describes subtle, iterative changes to an existing business model, value proposition, or offering—for example, a coffee shop offering a new kind of coffee. The business may have added a new product to an existing list, but the way fundamental value is created and delivered remains the same (the coffee shop produces drinks that it sells to customers).
In contrast, exponential innovation requires significant changes to the way value is created and delivered. Exponential innovation uses the power of network effects, which are often accessed, or at least aided, by new digital technologies. The opportunities and demands of network effects mean we may have to unlearn existing ways of working and limits on our businesses.
To truly engage in exponential innovation, organizations need to re-think their fundamental business model or add new ones alongside it, which is why business model innovation has become more prevalent in the digital age.
There are various terms for the components of a business model depending on the industry being described. The important thing is to ensure that the model describes the entire business, not just a few aspects of it.
The 'business model canvas' concept was coined by Strategyzer, whose books and tools for business model innovation have shaped modern thinking on strategy and testing of business ideas. It is a practical, widely-applied tool for mapping the essentials of a business model without getting mired in detail, and we will reference a few terms from that model to avoid confusion.
No business exists in a vacuum: partners, suppliers, and vendors are required to make any business model work.
Consider partnerships along all stages of a customer or user journey. Some of your partners may perform key activities or provide key resources required for a business model to work. Others may serve as a channel or support organization for customers and end-users. Key partners can also be select 'competitors' who share some needs with you. In one such partnership, Apple contracted with Samsung, which makes competing smartphones, to provide its displays.
The essential services and other functions an organization performs to create value for customers.
This includes activities needed for research, development, distribution, and support of an organization's offerings and platforms. Key activities are informed by an organization's value model(s): creating assets, providing services, generating ideas, and/or orchestrating networks. You can read more in Digital Value Models.
The most important assets, infrastructure, ideas, and technologies that the business model needs to work properly.
Consider financial resources as well as physical assets like production, office, or retail space.
The talented people inside an organization who provide services may be considered a resource to draw upon, though they are not a commodity.
Ideas (or intellectual property) like brands, copyrights, and datasets can be considered key resources, as can software, hardware, and other infrastructure.
'Machine coworkers' like artificial intelligence models and other advanced technologies are also a resource.
Finally, networks of people, organizations, and even machines can be viewed as their own type of resource.
The costs associated with operating the business.
Describe costs that are incurred by launching and operating the business and how they might change over time. Cost structures are informed by the value model(s) of the business. Does the organization create assets, provide services, generate ideas (intellectual property or technology), and/or orchestrate networks (like communities and marketplaces)?
Each has its own cost implications. Identifying which key resources and activities are particularly costly—and whether those costs scale linearly or not—is an important consideration.
As external forces change, some resources and activities may be less feasible or scalable. When considering cost structure, attend to fixed vs. variable costs, economies of scale, and scope. Technology companies Google and Apple constantly re-consider their scope, as when Apple stopped making wifi routers or Google started making smart home devices. Similarly, automakers like Ford trim product lines based on changing demand and costs, and app developers add and subtract features constantly.
The bundle of offerings (products, services, intellectual property, technologies, and networks) an organization will provide to create value for various customers.
Ideally, value propositions should reflect a shared purpose between the customer, the organization, and other stakeholders in or around the organization. Most organizations have several.
Value propositions match a customer's needs (or 'jobs to be done') with an organization's offerings. This is a critical element of any business model and often a starting place for new business models or significant business model innovation.
A value proposition should begin from the customer or end-user's needs.
You may also find it helpful to create or reflect on an organization's Strategic Narrative to stay focused during the value proposition design (or analysis) process.
It's important to distinguish between what a customer needs and the offerings and value models of an organization—they are not the same.
For example, taxi companies and ride-sharing services both help customers with the functional 'job' of getting from one place to another. But the value models they use and the offerings they provide are quite different. While they both offer rides, a taxi company does so by leveraging the assets of taxis and services of taxi drivers, while ride-sharing services leverage machine technologies to orchestrate a network of riders and drivers. The former owns taxis and employs people directly, while the latter mostly orchestrates third-party resources.
A company that is overly focused on its own operation, products, and services may lose sight of what actually matters to the customer—in this case, a ride.
The nature of the relationships an organization will establish with customers.
Customer relationships take many forms in the digital era. For each group of customers or users we serve, we should evaluate our roles in relationships (such as teacher-to-student or coach-to-athlete) as well as the location of our relationships. For example, are all customers assisted personally, or just some? Are they assisted in exactly the same way, or are there different experiences based on their needs or the channel used? Is the business entirely self-service? Do we provide communities and/or co-create with our customers?
The ways an organization connects with customers to communicate and deliver value propositions.
Consider where and how a company connects with customers and end-users. What is their journey? In a traditional business model focused on assets or services, customers go through a linear process: awareness of the company, evaluation of its offerings, purchase, delivery of specific value to them (be it physical or service-focused), and after-sales support, if applicable. This journey is less linear in the digital era, where companies may have hundreds or thousands of micro-interactions with a customer or user.
For example, a user may pay online using a service like PayPal embedded in a store's checkout process but not realize all of the other services PayPal offers until someone invites them to set up an account. Support may happen through self-service, a call center, a store, or even communities of other users.
The people and other organizations (individuals and/or organizations) who a business serves.
It's important to consider who an organization is creating value for or with. The idea of 'customer segmentation' refers to categorizing customers, often in terms of the paid transactions a firm has with them or their basic demographics. Practically, as a company considers how an it delivers value, it must ask which of the following it is serving:
The digital age requires a more nuanced understanding of the needs and desires of customers and users. This goes beyond basic facts about individuals to include communities, motivation, and personality. It can be useful to think of clusters of users who connect with the company based on common facets of their identity (such as progressive values) and a shared purpose with the firm (and other members of the larger ecosystem).
You can read more about shared purpose in our guide to Thinking for a Digital Era.
Sources of income in the business model
Does the company make money from one-time sales, recurring revenue like subscriptions, commissions, bulk purchases, or bundled 'solutions?'
Revenue structures can include specifics about pricing models as well as digital forms of exchange, such as token-based cryptocurrencies or game currencies. They may even reference non-cash 'income'—benefits like web traffic or user-generated content.
A business model environment describes forces outside of a specific business model that may still act upon it.
These include macroeconomic forces, domain (or industry) forces, social and technological trends, and market forces.
Effective business model innovation requires awareness and 'scanning' of the business model environment around you.
If you're not sure what changes are occurring in your field, try thinking in terms of shifts, such as the shift from rural to urban living or the shift from boxed software to subscription services.
You may also find it helpful to consider where 'unlearning' occurs—or needs to occur—inside or outside your organization.
Forces that affect how a business can deliver value, especially due to competition and innovation:
Large-scale influences which reach beyond the business world
Customer-side trends which affect demand, relationships, and channels: