What a business model is and why you care
There is a lot of business advice on how to make more money from your business by “hacking” one thing or another. The advice tends to center on specific tactics, you pay more money, and eventually, this web of hacks will generate cash flow. It won’t though, at least not if you don’t know what your business is.
The first step to growing your business, one that I see missed or ignored or overlooked by MSP owners and fortune 100 companies alike is to define the business model.
The business model explains HOW you make money, the value you provide to whom, and what you do to make your business work. To create a business that grows and makes money, you must have your business model well defined.
In this post, I go through the elements of the business model as defined by the Business Model Canvas, developed by Alexander Osterwalder, which is the most useful business model tool ever invented. I tried for years to invent my own… but this one is better.
Download a fillable business model canvas PDF.
In this post I cover:
What a business model is and why you care about your business model. Then I go into defining the elements and introducing the business model canvas itself.
From there I go through each of the nine elements of the business model:
- Step one: Define the Value Proposition.
- Step two: Who are your customers?
- Step three: How do you manage customer relationships?
- Step Four: What are your channels to market?
- Step Five: What are your revenue streams?
- Step Six: What are the key activities you engage in.
- Step 7: Key Partners
- Step 8: Key Resources
- Step 9: Your Cost Structure
Then I end with a couple of examples.
What a business model is
The business model is how you make money. On the customer side it specifies the value you bring to the market, the customers you serve, and what you will do to help them.
On the company side it outlines how you make money and where you incur costs.
We find that many MSP owners, many businesses, do not have a firm grasp on their business model. They don’t know exactly how they make money or what value they offer.
In plain terms, they “do stuff” and charge for it.
So often they end up looking for customers first, and then they figure out what they are going to do for those customers. There are even a lot of sales techniques out there that espouse this as a way of growing your business: understand the customer’s needs then develop a solution.
However, this is wrong.
If you are always reinventing your solution, you are always in invention mode, figuring out how you can solve your client’s problems rather than optimization mode, figuring out how you can grow your business.
Human-centric, growth businesses, start by understanding the business model fully and then building and expanding on it.
Why you care about defining your business model
There are three fundamental reasons why your business model matters:
- When you are starting a business understanding your business model is important because it helps you define, the value you offer, the resources you need and the customers you will attract.
- The business model is important for innovation: new innovations are often just business model innovations – shifts in how the business works rather than what the business does. Think of razors by mail: not a difference in the razor as much as a difference in how it is delivered.
- If you are growing a business understanding the business model will help you focus on your top priorities and invest in the right internal and external resources. It will help with the build versus buy decision.
Next I go through the business model itself.
Start by defining the elements of a business model
A simple form of a business model addresses who your customers are, what value you provide to them, and what you do to deliver that value.
The Red Sapiens business model, for example, is to help MSP owners (our segment/ our customers) build effective businesses that make money and help the MSP owners thrive (our value proposition).
What we do to deliver on this value proposition is to create educational content, provide coaching, and develop templates. Our resources are primarily people and their brains. However, we also use training facilities and some other resources along the way to deliver our programs.
Delivering our value proposition provides revenue and costs us money. We are in business if the revenue is greater than the cost.
The business model canvas
The business model canvas is a handy tool that guides you through thinking about your business model.
Alex Osterwalder developed it and published in the book, Business Model Generation. The book is great and the model is dead simple.
The model consists of nine factors that make up the business model. The right side is all about the customer, and the left side is about how you deliver, and the middle is your value proposition.
Once you capture the delivery, the value and the for whom, the model guides you to think about revenue streams and cost structure. Ultimately the value you bring should lead to revenue, your delivery is a cost, and you want to ensure that revenue is greater than cost.
There is a limitless opportunity to innovate the business model and create new opportunities in a changing market.
Understanding these nine elements is essential to creating a reliable business. So, we go through each one of these here.
Download our simple adaptation of the business model canvas to work on and capture YOUR business model.
Step one: Define the Value Proposition.
Your value proposition is why your customers care. You must have a clear understanding of why your customers will pay for your product or services.
Think specifically about:
- The problem in the market place that you observe and that you are fixing. Think of a low-cost airline: the problem they address is the high price of air travel.
- The benefit, or what your customers get out of working with you or buying your product. The benefit of low-cost airlines is getting to take that trip you wanted to take and spending less to get there.
- Your solution: what will you do to deliver this value, not all of the specific activities but certainly the big idea.
Step two: Who are your customers?
Here you want to get very specific about who your customer is. You cannot be all things to all people, and you cannot sell a niche product to all people. You must know your customers. What matters to them, what age are they, what income level, what education.
Think about segments; you may have different segments of customers. We sell coaching to smaller businesses and consulting services to large companies. They both relate to our value proposition but do so differently.
In defining your customers think specifically about:
- Define a niche: Cricket gear in the US is a narrow niche market, fragmented, distributed throughout the country but also passionate about their sport, this makes the segment very easy to sell and deliver to. The closer you can get to a niche like this, the easier it will be to run your business.
- Your market can be broad but must be well defined. The target market for the iPod was on some level everybody, but you can’t sell to everybody. So, it was for affluent people who wanted some style and design in the thing they carried around for music. Ostensibly anybody could wish to or buy one, but the target was someone interested in design.
- Quantify and understand these segments. Define how big they are and think about how likely they will be to buy your value proposition.
- Develop personas. The more you can personify your segment, the better off you will be. Get to know them, give them a name, be clear about who your segment is.
Step three: How do you manage customer relationships?
Customer relationships define how you interact with your clients. Do you want to have a purely transactional experience such as a retail environment or are you going to build a more interactive relationship?
As business coaches and consultants, we are interested in long term relationships that develop over time. This is a crucial part of our business model.
However, think of the low-cost airline: they spend as little time as possible on relationships with their customers.
What type of relationships will you build with your customer?
Step Four: What are your channels to market?
Channels are how you engage with, deliver to, or reach your customers.
They include all points of interactions from advertising to product delivery to technical service and support – every time you “touch” a customer, you do so through a channel.
So, think here about:
- How you interact with your customers: A low-cost airline delivers tickets through telephone and web, direct sales.
- How will you deliver your product/service: For example, will you have a retail presence or sell exclusively through online channels?
- How will you align your channels: Consistency across channels builds and promotes your brand and ensures consistent relationships. Different channels also provide various opportunities, Apple, for example, makes excellent use of packaging to communicate an experience.
Step Five: What are your revenue streams?
Your revenue streams are the products, services, activities that your customers are paying for.
In the case of the low-cost airline, they receive payment for flights as well as possibly additional services such as preferential seating and internet service.
Each of these is a revenue stream.
Facebook receives no revenue from its users but rather from advertisers; the revenue stream is advertising.
At Red Sapiens, we charge for training, coaching and consulting.
Knowing what you are charging for is very important – we often find that new MSP owners are not clear on their revenue streams. They don’t know what they are giving away for free and what they are charging for.
Step Six: What are the key activities you engage in.
This is all about the actions that you take and the things that you to deliver your value proposition.
You may sell a product that is manufactured by others, and your key activities are design and marketing. Alternatively, you may be the manufacturer of goods that others design and market. Or, you may do it all.
Ideally, you don’t want to do it all, and we will talk about key partners next, but you do want to know what part of the delivery is yours.
In the low-cost airline example, key activities include flying planes, turning them around at the airport, and managing customer interactions.
Plane maintenance would likely be outsourced to a partner.
Defining and redefining your key activities is essential and helps you focus on the core of what you do.
Note that as your business model develops your activities may evolve – technology may make outsourcing more viable or you may reach a scale where you need to take some activities in house.
Step 7: Key Partners
These are the people and organization you will work with to deliver the value proposition.
Many MSP owners try to deliver on their own, but this is a mistake – define your activities and define what others will do for you.
These are your suppliers or business partners you will rely on to make your business work. Software-as-a-service providers need a data center and hosting; a beer company may partner with distributors and bars to get their beer out.
Low-cost airlines partner with airports, airplane manufacturers, ground staff.
- Whom will you need to work with?
- What type of relationship will you have with your partner?
- Of your key activities, which could you potentially outsource to partners?
- What companies already deliver a part of your value proposition on your behalf? These may be manufacturers who can provide a piece, or all, of what you are building.
Step 8: Key Resources
Identify here the people material and equipment that you require to execute on your key activities and deliver your value proposition.
These are resources that you own or that report to you rather than to your partners. For an airline, these may be the airplanes (even if they are leased, which is a financial agreement, from a business model perspective these would be “owned” by the airline).
This includes the human resources and intellectual property that you will require.
There may also be financial resources; a bank, for example, requires capital to operate.
The important thing here is to know and recognize what resources you require.
Step 9: Your Cost Structure
Everything that you do to deliver on your value proposition will lead to and incur cost. These are the elements that make up your cost structure.
This includes everything from operations to licensing to delivery of your good or service.
A manufacturer would have to consider manufacturing cost and all of the elements that make up manufacturing. Alternatively, an import company would purchase manufactured goods, and that would make the basis of their cost.
The airline has to pay for fuel, pilots, reservations systems, everything that they need to fly.
Clear and detailed cost analysis is key to ensuring profitable development. Startups must understand their cost profile from cash, not accounting, perspective, and plan what cash will be required when.
Moreover, understand that YOU are a cost. One of the biggest mistakes we see is people discounting themselves and charging nothing for their time. Your time has a cost, so be sure to include that in your calculations.
Those are the elements of the business model and identifying your business model and mapping it out so that you understand precisely what you do and for whom should be the first part of starting your business. Only through understanding your business model can you grow your business while ensuring that you are making money and delivering value.