A business model is an essential part of any company’s foundation and should be well thought out and constantly reviewed.
This is because regular updates help to consider all possibilities ahead.
In addition, failure to reflect on how a potential solution might impact the business will lead to unstable situations that are hazardous for both employees and customers alike.
To avoid such problems, which can result in loss of revenue, managers need to review their business plan regularly by letting top management assess it and make sure that it’s up-to-date to avoid any kind of mistake or omission in the long run.
Assessing Business Models
A business model is the initial plan of the company that you constantly experiment with and adapt while mapping out your course to success.
It should be centered around a value proposition to highlight exactly what sets your product or service apart from its competitors.
Since a business plan involves financial forecasting, it will also contain projections of resources you need for the tools, equipment, or infrastructure needed for your startup and the cash flow throughout your first year of operation.
You may want to find out which kind of investors are best suited for funding new businesses.
Successful companies will fill their market’s needs and sustain a profitable business along the way.
It’s equally important to keep the finances balanced so that revenue is constantly flowing in while spending stays at an acceptable level.
When evaluating a potential investment, the investor should evaluate the business model to determine how exactly it makes its money.
However, this doesn’t mean that these facts will tell you everything about the company’s prospects.
But if you understand its business model then you can better comprehend and interpret the financial data with ease.
Different Business Model
Business models can be broken into four unique categories.
Direct sales, franchising, retailing, and traditional business models.
Each plan falls under one of these categories. For instance, Gillette is pleased to sell its Mach3 razor handle at cost or for a lower price to get steady business from its more profitable razor blades.
This business model knows that the real cash is made with the dependable customers, because of the dependent good, which means their blades.
If one was to go by this model, they could notice that it pays off to give away the handle to ensure a sale on something essential making it a pricier investment and purchase in comparison.
Though, not just anyone could apply this type of business model depending on what company you happen to be running since it might get a little confusing for your audience if you don’t use any examples directly related to what you are explaining.
Criticism of Business Model
The former editor of the Harvard Business Review, Joan Magretta suggests there are two factors critical to business model sizing up.
First and most importantly, she states, ‘It’s about making sense.’ If the business model for not working doesn’t make sense, then it’s doomed.
The airline industry is a good place to look at for this example.
Airline companies that did well in the past like US Airways now suffer heavy losses and even bankruptcy because their business model has become outdated in an era where consumers are looking for more from the airlines than simply getting from point A to point B as cheaply as possible.
The second factor critical to assessing a business model according to Ms. Magretta is whether or not there will be profits and also monetizing your pain points or what she calls being able to “prune out costs when necessary”.
For years, major airlines like American Airlines, Delta, and Continental structured their businesses around a hub-and-spoke business model in which all flights were routed through a handful of major airports.
This strategy made the carriers profitable by ensuring that most seats were filled most of the time.
But soon many competitors followed with alternative business models that took advantage of efficient carrier services and forced down operational costs to become profitable themselves.
One such service was Southwest Airlines, which shuttled planes between smaller airports with greater frequency at a lower cost.
By avoiding some of the operational pitfalls of the competing hub-and-spoke model while relying on flexible labor costs, the new businesses experienced tremendous growth in the airline industry.
As new airlines were entering the market, they were stealing away passengers from their older competitors.
The problem became worse when customers started booking fewer flights after the 9/11 terrorist attacks in 2001.
To fill seats, these carriers had to offer more discounts for less which caused business to suffer and put lesser importance on the spokes since most of the money coming in was by way of the hubs.
Examples of Business Model
It’s easy to get caught up in dollar signs and forget what the numbers mean.
Is your company doing well because of sales or profits?
Sometimes it’s hard to tell from the bottom line alone, which is why considering a comparison of two companies who don’t operate with the same business model can shed some light on numbers that might not make sense until more analysis is done.
For example, take A corporation vs Company B. Both companies earned $5 million in revenues last year.
However, Company B also spent $4 million on its inventory of products while A spent only $3 million on its inventory.
This means that at the end of the day each made a gross profit calculated as $5 million minus $3 million, or $2 million.
That’s a significant difference when you’re comparing two similar companies.
But things gradually changed with the arrival of the internet.
Company A decided to stream movies online rather than rent or sell physical copies, as a result of this change.
The licensing fees did not, though the cost of holding inventory did go down substantially.
The new gross profit for the company was $5 million minus $2 million and it was now at 60%.
Meanwhile, company B failed to update its business plan and so was stuck with a much lower gross profit
margin.
Its sales began sliding downwards quickly as a result of this mistake, with company A even making less in sales but revolutionizing its business model nonetheless – which had greatly reduced its costs.
