A business model describes the rationale of how an organization creates, delivers, and captures value – economic, social, or other forms. The process of framing the right business model design is an integral part of the company’s business strategy.
In theory and practice the term business model is used for a broad range of informal and formal descriptions to highlight its basic objectives like its vision, core competencies, strategies, infrastructure, organizational structures, trading principles, and operational processes and policies.( Changing Business Models: Surveying the Landscape, J. Linder and S. Cantrell)
The essence of a business model is that it defines the ways by which the business enterprise delivers value to customers, entices customers to pay for value, and converts those payments to profit: it thus reflects management’s intention of what customers want, how they want it, and how an enterprise can organize to best meet those needs, get paid for doing so, and make a profit. After all the future of any company lies in the value that they deliver (David Teece 2010). Business models are used to describe and classify businesses (especially in an entrepreneurial scenario), but they are also used by managers inside companies to explore possibilities for future development, and finally well known business models operate as recipes for creative managers.
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2. Role and Importance
Nowadays, the business models used depends on the technology levels in the organization. Top level managers have created entirely new models that depend fully on existing or emergent technology. Using technology, businesses can reach a large number of customers with minimal costs. Such is its importance in today’s world that a properly framed business model provides clarity to any business.
To identify and create value from an innovation, a start-up needs a well structured business model. Business models transform latest technology into outputs at the economic level.
For emerging firms in industry, established business models cannot be followed, therefore there is a need to frame a new business model. Not only is the business model important, in some situations, innovation lies not in the product or service offered but in the business model itself.
Taking into account the complexities of products, markets, and the environment in which the firm operates, very few individuals fully understand the organization’s tasks and objectives in their entirety. The technical experts and the business experts know each of their domains clearly.
3. The Domains of Business Model
The conversion process that a business does is shown in the following diagram:
A business model covers a plethora of business subjects, which includes financial, marketing, operational and entrepreneurial strategies. The business model itself is an important determinant of the firm’s revenues to be made from an idea. A well framed business model can outshadow even a weak innovation but a weakly framed business model will hide off a good innovation.
Following are the six major elements in business models:
Value proposition – a clear description of the root cause for customer need, the product that will satisfy the need, and the delivered value of the product from customer’s view.
Market segment – the genre of customers to target, recognizing the fact that different market segments have different needs. Sometimes the capacity of an innovation is revealed only when a different market segment is targeted. In short, the ‘segmentation, targeting and positioning of value’ (STP).
Value chain structure – the point in the value chain where the firm is and how it shall capture that part of value.
Revenue generation and margins – how the firm generates revenue in sales, leasing, subscription, support, etc, the pricing, and projected profit margins.
Position in value network – locating the firm’s competitors and complementors, and any networking that can be done to deliver more value to the customer.
Competitive strategy – what strategy the company will implement, pricing, differentiation or niche strategy, to gain a competitive edge in the market.
Following diagram is another representation of components:
5. Business Model vs. Strategy
A business model is often mistaken for a business strategy. A firm must avoid using them interchangeably. Following are three main differentiators between the two:
Creating value vs. capturing value – a business model aims at creating value. While it also includes how that value will be captured by the firm, a business strategy focuses on building a sustainable competitive advantage.
Business value vs. shareholder value – the business model is responsible for transformation of ideas into valuable outputs. However, the business model does not focus on delivering this value to the end customers, but a business strategy does. For example, business model does not elaborate on financing methods, but they affect the stakeholders’ intentions.
Predetermined knowledge levels – the business model requires only a basic level of knowledge, whereas strategy involves application of conduct more than knowledge of the environment. ( Henry Chesbrough, Open Innovation : The New Imperative for Creating and Profiting from Technology)
Business models have been defined and categorized in many different ways. The basic categories of business models include the following areas as criterion:
The above models can be applied in an organizational scenario in different ways. A company may make use of various small business models to frame out its overall strategy. For example, for firms with content driven business models, Advertising shall be a part of subscription model.
6. Business Models-Part of Strategic Management
Strategic or institutional management is defined as ‘The conduct of drafting, implementing and evaluating cross-functional decision making that will enable an organization to achieve its long-term objectives’. It is the process of charting out the organization’s mission, vision and objectives, developing policies and plans, often in terms of projects and programs, which are designed to achieve these objectives and then allocating resources to implement the policies, and plans, projects and programs. Framing a business model helps carry out the above practices.
A business model includes every aspect from how a company makes profit to how it structures its business. Mostly, these constitute the components of a business model. For example, the clicks-and-mortar business model. This elaborates how a company allows access to itself through the Web which is hardly a complete business model.
A well structured business model is any organization’s crux of creating value. More specifically, it is:
The set of value propositions an organization offers to its stakeholders, along with the operating processes to deliver on these, arranged as a coherent system that both relies on and builds assets, capabilities and relationships.
To create value
A business model is divided into many parts and each part is again called a business model by itself.
7. Characteristics of Business Model
Research of over 70 companies’ business models says that there is no such model which the best in producing financial results; however, the comparatively successful models possess the three following characteristics.
7.1 Unique value offering-this comes mostly in the form of a new idea. Mostly the offering is in the form of a combination of a product and a service; low price same benefit or same price greater benefit.
7.2 Excellence is hard to imitate-by building up a key differentiating factor like good execution; these models build barriers to entry in market that will protect their profit streams and from other competitors.
7.3 Successful models are backed up hard by reality-since they are framed on the basis of accurate customer feedback. The cost structure would be compatible with the revenue earned. However, many firms lack a clear understanding of where they create revenue, why customers prefer their product or service over the competitors and which customers actually bring revenue.
The main factors for which businesses compete against each other are competitors and resources, so in a business model the following aspects should be properly be covered- competitive edge, investor attraction, profit earning capacity; etc. The components of an effective business model are linked with each other and are backed with good detail: if the firm changes any one factor it gets a different model.
8. Changing Business Models
However well designed a model is, it does not last forever in the market. The business model should constantly update itself from changing customer needs, market needs and the competitors.
The following are six common approaches for a business model to changes in market conditions:
Showing proportional change by extending business model
Geographical expansion, widening customer target, rearranging prices, extending product and service lines can be some ways of extending business model. By making these small changes the firm can achieve a boost to the existing business model. For example, a company called W.W. Grainger’s customers enjoy convenient placing of orders-through geographical branches, phone, fax or teletype machines. Adding Web channels to sales strengthened Grainger’s business model.
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Changing the distinctive factor of the existing business model
When there is competition based on price, the firm changes its value proposition by redefining its existing business model. Teradyne, for example, market leader which manufactures semi conductor testing equipments, ropes in customers with innovative products but brings in revenue through a steady stream of product enlistments and efficient service. The company’s value proposition is its leading edge products and trustworthy service. To rejuvenate its business model, Teradyne periodically introduces breakthrough products that sets it go.
Replicate a model in new domains.
By using same business formula, companies introduce new products into new markets. This is known as replicating the business model in new domain. Example, Aurora Foods and the Gap. Aurora Foods buy unpopular brands like Aunt Jemima Waffles and Lender’s Bagels and makes use of its marketing strategies and cost cutting measures to give those brands a lift up in market. Likewise, the Gap applies its brand marketing and merchandising experience to create entirely new retail signatures like BabyGap, Banana republic, and Old Navy Clothing.
8.4 Including other models of acquisitions to firm portfolio
Through acquisitions and mergers companies regain their operating positions. For example, Seagram’s which is basically a wine and spirits company, ventured in as an entertainment firm. It acquired Vivendi another French company hoping to use its cellular telephones, pay television, and Internet portals to distribute Seagram’s’ entertainment content.
8.5 Identifying existing capabilities and implementing to create new models
By identifying their skills and capabilities, companies grow their business models. For example, the Canadian company Bombardier which manufactures snowmobiles got a foothold in financial services by selling on credit then moved into capital leasing. Experience in manufacturing snowmobiles threw light on many opportunities in large scale manufacturing, including aircraft for the firm. Based on leasing experience and aviation background, Bombardier Company offered fractional jet ownership to corporations and high-net-worth individuals. Thus, Bombardier has leveraged the capabilities, knowledge and relationships that it developed as part of one model to create the next.
Making fundamental changes in the model
A whole new transformation of organisation structure, culture, and the values. The transformation being quicker, more drastic and sudden the change will be. During the process of an idea changing into a product and it being introduced to the market, the firm usually faces the dynamic change environment. (Managing a digital enterprise-Michael Rappa)
9. Implications For The Company Through The Apt Business Model:
Through a management perspective:
Clarity in business model is a pre requisite to focus. Internal awareness about the business model and how it contributes to achieve long term objectives is necessary to each person in the organisation. They should also be aware of the competitive edge and the revenue factor of the firm. If they did, their everyday decisions and activities would complement firm’s profit-making agenda more strongly.
Making change an integral part. For smooth execution the company should structure out various ways to change.
Getting prepared for dynamic competition. The company should start planning with the business model in mind first instead of the organisation as a whole. Exploring new agendas and striking favourable combinations by leveraging capabilities and skills. (Jane Linder and Susan Cantrell- Article on what makes a good business model anyway?)
Just like the framing of a long term vision for an organisation, a well thought out and forecast business model helps guide the organisation towards systematic clean achievement of objectives. The trick lies in framing and implementation of The Right Model…
I would like to thank our professor Mr. DM Sezhiyan, Department Of Management Studies, National Institute of Technology, Trichy for his encouragement and support throughout this work. He not only guided me but also helped me with the topic to understand, and communicate it to this paper.
I would also thank Dr. M. PUNNIYAMOORTHY (Head of the Department), National Institute of Technology, Trichy who has been a constant source of motivation and support all through the work.
Finally I would like to thank my family and well wishers for their boundless love and constant encouragement.
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