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Evaluating Your Business Model

FastTrac, Kauffman Foundation

As part of the planning process, evaluate your business model to ensure that the current model will support your plans for growth. If your business strategy changes, you may need to modify your business model to align with it.

A business model is the method by which an organization uses its resources to deliver value to customers while maximizing profits and growth for itself. The model provides a structure or framework for delivering products or services to an intended audience. The business model includes these elements:

  • Type of customers to serve
  • Ways customers use the product/service
  • Distribution
  • Promotional strategy
  • Operational tasks to be performed
  • Resource requirements
  • How profit and revenue is generated

Two businesses that sell the same product or service can have quite different business models. For example, both Dell, Inc., and CompUSA® sell computers and peripherals. Dell receives orders via the telephone or online, receives payment from the consumer before the computer is even built, builds the computer, and ships it directly to the consumer. CompUSA is a retail operation, selling various brands of computers it has purchased from manufacturers or distributors. The choice of business model has a profound effect upon all aspects of their businesses.

Types of Business Models

Some of the common business models are highlighted below, although many entrepreneurs develop hybrids that incorporate features of several different models rather than just one or the other.

Bricks and mortar – The oldest and most basic business model is the storefront where companies maintain a physical location and offer products or services to customers. Customers buy on location. In recent years, retailers have expanded their bricks and mortar model to include an online presence. This practice, called the clicks-and-bricks model, allows customers to buy online and pick up at local stores or have products shipped directly to them.

Subscription – A business model originally developed for magazine and record clubs is now finding many new applications. The subscription business model allows a company to generate recurring revenues, usually on a monthly or yearly basis. Other industries that have adopted this model include cable and phone companies, newspapers, Internet providers, software providers, and health clubs. This model generates a constant stream of revenue and provides convenience for customers who buy once and receive products or services for a period of time.

Bait and Hook – Years ago, Gillette developed a model to hook customers with the purchase of an initial product—their safety razor first manufactured in 1903. Customers would then be hooked into purchasing supplemental products, such as disposable razor blades. This model is implemented with products such as cell phones and airtime, printers and ink cartridges, and cameras, film, and prints.

Multi-level marketing – Also referred to as the network marketing model, independent distributors buy products from a parent company, sell products to consumers, and create a downline (or network) of other distributors who do the same. The independent distributors receive a profit generated from their own sales and sales of their downlines. Mary Kay®, Melaleuca®, and Longaberger® are multi-level marketing companies.

Direct Sales – The direct sales business model eliminates the middleman and increases the sale-to-delivery speed of a company’s products to consumers. Popularized by Dell, this model capitalizes on customers who buy directly from the manufacturer. Since no additional margins are paid to middlemen, the cost of sales is less, and customers buy at reduced prices. For example, airlines often give a small discount to customers who book tickets on their Web sites. Some manufacturers may prefer, however, to use middlemen to streamline the sales process, share the costs for local marketing, and reduce costs by consolidating goods and services for distribution.

Auction – This model provides a process of buying and selling goods by offering them up for bid. The traditional auction-house business model is usually associated with antiques and collectibles such as stamps, coins, classic cars, and fine art. While this business model is very old, the Internet has created an online auction version. The world’s largest online auction site, eBay® allows people from all over the world to buy and sell all kinds of goods, generating countless new auction business opportunities for entrepreneurs.

Service – The service industry is a large category of our economy and presents the most complex and challenging business models. The service sector consists of such industries as insurance, tourism, banking, education, franchises, restaurants, transportation, healthcare, consulting, investment, and legal services, among others. The problem that many service providers face is how to deliver quality services efficiently and effectively every time. A typical service business model may focus on increasing customer satisfaction, which leads to loyalty, which leads to profitability. The increase in profitability is related to customer retention. It’s typically less expensive to keep existing customers than to acquire new ones.

Collective business system – This model offers businesses, tradespersons, or professionals in similar or related fields opportunities to pool resources, share information, and gain benefits by paying fees to belong. Trade associations, cooperatives, and franchises are based on this model. The premise of this model is that its members with common interests can support one another to successfully compete in the marketplace.

  • Trade associations – Members pay annual and user fees to market, network, access information and education, and purchase products and services through group purchasing plans. The association may also collect rebates or commissions from purchasing programs.
  • Cooperatives – These entities are similar to trade associations, but members have an equity interest by owning a portion of the cooperative. Members participate in group purchasing plans, buy or lease commercial space, and share in the risks and profits of conducting business. Members receive profits or dividends from sales.
  • Franchises – Borrowing concepts from the manufacturing sector, franchises perfect branding, production, procurement, and operational procedures so that they can be replicated in different geographical locations. Members buy the rights to operate a franchise in a geographical location from the franchiser, or parent company. In addition to the initial franchise fee, members of franchises buy products or services and pay a percentage of their sales to the franchiser.

Online delivery – The Internet has given rise to new variations of business models. Internet models allow companies to sell their own products or services, sell others’ products or services, or promote and connect buyers and sellers. Here is a quick glimpse at a few Internet models:

  • Brokerage – A broker provides a service by bringing buyers and sellers together for a transaction fee. Examples of the brokerage model include Orbitz®, Priceline®, eBay, Paypal®, Amazon.com, and Shopping.com®.
  • Advertising – A Web site provides content services and makes its money by selling advertising. The advertising revenue is in direct proportion to the volume of viewing. Yahoo!®, Monster.com®, Google®, and Marketwatch® are examples of this model.
  • Infomediary – An independent entity analyzes Internet consumption habit data and sells it to firms for use in target marketing. Likewise, they analyze markets for consumers. Edmunds® and Double-Click® are examples of this model.
  • Information – A Web site creates a depository of articles, publications, videos, or other media and sells them to distributors or end-users who want to buy the information. Hoovers®, Dun and Bradstreet®, and Knowledge Storm are examples of this business model.

The success of your company is directly related to how well your business model matches your customers’ expectations. The CEO Refresher’s Establishing a Continuing Business Model Innovation Process by Donald Mitchell and Carol Coles states that successful high-growth companies revise their business models according to customer preference as often as every two to four years.

Change with the Times

Olin B. King founded Space Craft, Inc., in Huntsville, Alabama. King started his business in the basement of his home in 1961 with two friends whose goal was to design and build satellites. They had built only three before that program was transferred to NASA from the U.S. Army. Later they set out to manufacture subsystems for the Apollo mission, completing fifteen systems before the Apollo program came to a halt.

Back to square one, SCI began to manufacture subsystems for F4 jets for the Department of Defense, building thousands before it found itself, once again, searching for a new market need to fill. In the late 1970s and early 1980s, SCI made computers for IBM and evolved into a Fortune 300 company.

In just a few years, SCI grew from a handful of people to thousands of employees working in plants all over the world. Some industry analysts dubbed Mr. King the “Father of Contract Manufacturing.”

Mr. King will tell you it wasn’t easy; in fact, he found he had to reinvent his company and his business model a number of times. Although SCI began as an engineering services business, it continued to adapt until it evolved into a contract manufacturing business model.

In 2001, when SCI Systems, Inc., was acquired by Sanmina® for $6 billion, SCI was a publicly-traded company operating forty-nine facilities in nineteen countries and employing more than 35,000 people. Analysts projected this merger would create one of the most respected and successful companies in the $130 billion global electronics contract manufacturing industry.

© 2006 Ewing Marion Kauffman Foundation. All rights reserved.

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