What is a Business Model?
At its simplest definition, a business model outlines your business’ core strategy for profitability and how you will achieve it. A strong business model should be able to answer these four key questions:
1. What is my cost structure?
2. What is my revenue structure?
3. What is my competitive advantage?
4. How can I keep my costs low?
We’ll go into depth for each of the questions below.
1. What is my cost structure?
Cost structure is any fixed or variable costs that a business incurs. This can include but is not limited to production cost, selling cost, and administrative cost. Let’s dive a little deeper into each.
- Production cost refers to how much it will cost to make the product or service. This includes designing, raw materials, labor costs, etc.
- Selling cost is the marketing and advertising, distribution channels, packaging, and costs related to the actual sale process, like POS systems.
- Administrative costs are incurred when you start running the business and throughout the business cycle. These costs are usually for the business as a whole, and not directly related to a specific operation or production. General examples of variable administrative expenses are office supplies, legal fees, and accounting fees.
2. What is my revenue structure?
Revenue streams determine how your business will generate cash and through which channels. Some examples of revenue streams are transactions-based, reoccurring, or project-based.
- Transaction-based revenue is generated on a one-time payment basis.
- Recurring revenue is generated based on an on-going basis. Normally these revenues are prepaid or contract-based, which guarantees and allows you to determine incoming revenue.
- Project-based revenue is generated based on project agreements.
Another factor to keep in mind as you’re determining your revenue structure is your pricing strategy. Pricing strategy is used to help you decide how to determine the price of your product or service. There are a lot of pricing strategies to choose from. Ideally, you would want your price to at least cover your costs and expenses but also be able to attract customers. Here are a few pricing strategies you can consider.
- Value–pricing is setting a price based on what you think the customer is willing to pay. To determine this, you should become familiar with who your target customers are and their buying behaviors. Surveys are a great tool to determine this.
- Market penetration pricing is setting a price low to enter the market and then increasing it after you’ve established a presence in the market.
- Premium pricing is setting a price that depicts a luxurious or premium value. This normally works well for products or services that have established a perceived cognition of prestige value.
- Cost-plus pricing is setting a price that covers the costs to produce the product or service plus a mark-up that covers the cost of doing business and creates a profit.
- Competitive pricing is using a competitor’s pricing as a benchmark. You can set your price a bit lower, similar to, or the same as your competition.
3. What is my competitive advantage?
Ultimately, your cost, revenue, and pricing strategies factor into your competitive advantage. Gaining a competitive advantage doesn’t happen overnight. To achieve this, you will need to determine what value you provide over your competitors. Can I offer a competitor's product or service at a lower price? Is the product or service I am offering new or in a niche market? Is it unique?
In theory, if you want a higher net profit margin, you want to keep costs low and revenue high. At the same time, you have to balance that with the ability to attract and delight customers. There are a few different profit margins and formulas to help calculate these profit margins that you can consider when building your business model.
4. How can I keep my costs low?
Beginning a business can result in a lot of start-up costs that don’t seem to be much when you look at them on a stand-alone basis, but when you start adding them up together, they really do add up! There will be costs that you can recall at the top of your head, costs that you would’ve never really thought about, and also unexpected costs associated with running a business. However, that doesn’t mean all your costs are fixed and can’t be reduced. Below are some creative ways you can reduce costs.
- Buy everything in moderation and what you think is necessary. A very common mistake that a lot of businesses make is overspending and being over-prepared. Being prepared is not a bad thing at all! It is completely normal to be excited about your business and to want to be ready to run but sometimes over-spending can cause more damage than good. Businesses often find themselves having too much inventory and supplies that might not be used in the future or might not be a fit for future operations.
- Do your research – try and test! You might want to buy the most reputable or most expensive or heard good things about certain purchases, but to quote Frank Zappa, “One size does not fit all.” Do your research and don’t be scared to test a few options out before making the big decision. What works for others won’t necessarily work for you, but you won't know until you have tried it out. More expensive doesn’t always mean better. There are often a lot of less expensive options that can perform just as well or even better.
- Contracts and Agreements. If you find a good supplier for your materials or products, consider initiating a contract. Purchasing bulk orders and establishing a long-term relationship with these suppliers can possibly lead to savings or perks.
Key Takeaways
- A business model is your plan on how to make a profit. It outlines your product and services, target market, and revenue and expense predictions.
- When you are pricing your product or service, you should keep in mind that the pricing strategy is for your target customers. You should establish who you want as customers and determine your pricing strategy based on these factors.
- Keep track of your expenses – big and small. Every expense counts when it comes to your business and it allows you to see where all your cash inflow and outflow are coming from and going to.
